I blog this, I can help you out if you need.
Just come down to vanier commonsblock thursday or friday afternoon, or if that doesn't work for you, just send me an email- jsussman@telus.net
Thursday, December 10, 2009
Free ECON 101 Tutoring
I blog this, I can help you out if you need.
Just come down to vanier commonsblock thursday or friday afternoon, or if that doesn't work for you, just send me an email- jsussman@telus.net
Friday, December 4, 2009
Cases Against Government Intervention!
Not every case where the government intervenes in the economy is optimal. There are many cases where intervention is probably not the best idea: for an example, should the government go crazy with spending on new infrastructure and facilities just because vancouver won the bid for the olympics?
So, what determines whether governments should intervene or provide public goods? Well, it depends on whether the social costs outweigh the social benefits (the total social costs and total social benefits- this is includes both private costs and benefits, and externalities). The social costs are the total opportunity costs of a government intervention (eg: should there be marginal cost pricing for vancouver translink? Well, the social costs are the taxpayer dollars which could have been spent in other ways: ie, to lower UBC tuition). The social benefit of an intervention is the cost of the market failure which the intervention prevents. Sometimes, by intervening and attempting to correct a market failure, a government incurs an even larger social cost than the market failure would have caused.
So is there a social benefit to a new skating oval in richmond? Absolutely not! There was no social demand for this skating oval prior to the olympics, and the money could have been spent on much more important things (eg: social housing)
PROBLEMS WITH COST-BENEFIT ANALYSIS?
-How do you quantify subjective costs and benefits to society (eg: the happiness something will bring, the future problems pollution could cause, etc)?
-It can be difficult to forecast the future, and many economic predictions rely on predictable futures (case example: many provincial governments went WAY over budget in 2009, because they did not anticipate the economic meltdown).
-Governments often discount future costs in order to benefit the present (the olympics is a perfect example: vancouver and the BC government are spending billions of dollars on a small party, which we will have to pay off, with interest, for years and years in the future)
METHODS OF GOVERNMENT INTERVENTION:
-Public provision versus user-pay: is it better for the government to own and provide a particular service, or is it better for the government to contract that service out to the private sector, and then just pay the private sector for their work? **Note: check out the handi-dart strike in Vancouver if you want a really cool look at some of the problems that can result from contracting out public work to the private sector. This goes against the right-wing principles of Gatemanism, but its definitely worth a look.
-Regulation (some problems are that there are costs to enforcing regulations, and most firms can find some kind of legal loophole to get around enforcement)
-Redistribution of income (Taking money from the rich and giving some to the poor through different social programs. socialism! Yay!)
COSTS OF INTERVENTION:
-Direct costs: The government uses real resources (ie: steel to make military vehicles)
-Indirect costs/externalities: ie, extra costs of production due to safety standards and environmental control (eg: safety goggles and pollution filters cost money), costs of compliance (eg: Red tape and pay equity), and the cost of Rent seeking (where companies pay for lobby groups to lobby the government for economic advantage).
WHY DOES THE GOVERNMENT OFTEN FAIL WHEN INTERVENING IN MARKETS? Most of the causes of government failure are systemic- they occur naturally within the system of government intervention.
Public Choice Theory:
-There are three different stakeholders for government policy
Politicians: They want to maximize their political power
Bureaucrats: Want to maximize authority and salary
Electorate: Want to maximize utility
The electorate want to maximize their total utility, and often, this is achieved when private citizens choose to IGNORE political-economic policy issues. This is called RATIONAL IGNORANCE: There is no incentive for the electorate to become informed when they only have one vote each. As a result, government can get policies which hurt the electorate passed because we don't have the information to stop them.
Rent Seeking: Special Interest Groups have an inordinate ability to lobby the government and get policies created which benefit them at the expense of everybody else.
Democratic Inefficiency and public Choice:
-One vote fails to account for preferences (so people have, in reality, very little control over the decisions the government makes)
-There is a TRADEOFF between democratic processes and efficiency (so the more democratic something is, the longer it takes to get anything done. Key examples of this include governments like Weimar Germany, which were socially democratic, but incredibly inefficient. In Weimar germany, the merits of everything had to be weighed and voted on, so it took them ages to actually get anything accomplished. Fascism, although often terrible, is much more efficient than democracy).
Government Monopolies: In industries in which there are government monopolies, there are no market forces to create innovation and further efficiencies, which can lead to stagnation. This is not good! Think of Canada Post, and how inefficient it is!
OKAY, so what is the optimum level of government intervention? Well, to decided that, you have to compare the market with government performance. Usually, this involves making value judgements, which is why so many different countries have different levels of government intervention in their economies: they have made different value judgements!
THAT'S THE END OF ECON 101!
HERE IS THE TAKE HOME MESSAGE:
1: Assume nothing. Why? Well, economics is all about putting together arguments. In order to make a good argument, you need to get rid of your assumptions, don't jump to conclusions, and evaluate the evidence clearly for yourself. Make sure your arguments are based on observable, provable facts, and not sound-bites which you've picked up from different sources.
2: Rational Wisdom: Using your smarts with a broader perspective!
-You're at least as smart as the next person. There's even the chance that you might be smarter.
-There are benefits to this: we probably get to become important people.
-On the other hand, you must use your smarts with humility and responsibility. Don't be arrogant- instead use your powers for good.
Congratulations on finishing Econ. It's study time. If you read these notes at all, share them with your friends. I'm probably going to be organizing some small scale, not-for-profit review sessions for anyone who's interested over the next couple of weeks. I'll be making a post here as soon as I've got times and dates figured out for that.
So, what determines whether governments should intervene or provide public goods? Well, it depends on whether the social costs outweigh the social benefits (the total social costs and total social benefits- this is includes both private costs and benefits, and externalities). The social costs are the total opportunity costs of a government intervention (eg: should there be marginal cost pricing for vancouver translink? Well, the social costs are the taxpayer dollars which could have been spent in other ways: ie, to lower UBC tuition). The social benefit of an intervention is the cost of the market failure which the intervention prevents. Sometimes, by intervening and attempting to correct a market failure, a government incurs an even larger social cost than the market failure would have caused.
So is there a social benefit to a new skating oval in richmond? Absolutely not! There was no social demand for this skating oval prior to the olympics, and the money could have been spent on much more important things (eg: social housing)
PROBLEMS WITH COST-BENEFIT ANALYSIS?
-How do you quantify subjective costs and benefits to society (eg: the happiness something will bring, the future problems pollution could cause, etc)?
-It can be difficult to forecast the future, and many economic predictions rely on predictable futures (case example: many provincial governments went WAY over budget in 2009, because they did not anticipate the economic meltdown).
-Governments often discount future costs in order to benefit the present (the olympics is a perfect example: vancouver and the BC government are spending billions of dollars on a small party, which we will have to pay off, with interest, for years and years in the future)
METHODS OF GOVERNMENT INTERVENTION:
-Public provision versus user-pay: is it better for the government to own and provide a particular service, or is it better for the government to contract that service out to the private sector, and then just pay the private sector for their work? **Note: check out the handi-dart strike in Vancouver if you want a really cool look at some of the problems that can result from contracting out public work to the private sector. This goes against the right-wing principles of Gatemanism, but its definitely worth a look.
-Regulation (some problems are that there are costs to enforcing regulations, and most firms can find some kind of legal loophole to get around enforcement)
-Redistribution of income (Taking money from the rich and giving some to the poor through different social programs. socialism! Yay!)
COSTS OF INTERVENTION:
-Direct costs: The government uses real resources (ie: steel to make military vehicles)
-Indirect costs/externalities: ie, extra costs of production due to safety standards and environmental control (eg: safety goggles and pollution filters cost money), costs of compliance (eg: Red tape and pay equity), and the cost of Rent seeking (where companies pay for lobby groups to lobby the government for economic advantage).
WHY DOES THE GOVERNMENT OFTEN FAIL WHEN INTERVENING IN MARKETS? Most of the causes of government failure are systemic- they occur naturally within the system of government intervention.
Public Choice Theory:
-There are three different stakeholders for government policy
Politicians: They want to maximize their political power
Bureaucrats: Want to maximize authority and salary
Electorate: Want to maximize utility
The electorate want to maximize their total utility, and often, this is achieved when private citizens choose to IGNORE political-economic policy issues. This is called RATIONAL IGNORANCE: There is no incentive for the electorate to become informed when they only have one vote each. As a result, government can get policies which hurt the electorate passed because we don't have the information to stop them.
Rent Seeking: Special Interest Groups have an inordinate ability to lobby the government and get policies created which benefit them at the expense of everybody else.
Democratic Inefficiency and public Choice:
-One vote fails to account for preferences (so people have, in reality, very little control over the decisions the government makes)
-There is a TRADEOFF between democratic processes and efficiency (so the more democratic something is, the longer it takes to get anything done. Key examples of this include governments like Weimar Germany, which were socially democratic, but incredibly inefficient. In Weimar germany, the merits of everything had to be weighed and voted on, so it took them ages to actually get anything accomplished. Fascism, although often terrible, is much more efficient than democracy).
Government Monopolies: In industries in which there are government monopolies, there are no market forces to create innovation and further efficiencies, which can lead to stagnation. This is not good! Think of Canada Post, and how inefficient it is!
OKAY, so what is the optimum level of government intervention? Well, to decided that, you have to compare the market with government performance. Usually, this involves making value judgements, which is why so many different countries have different levels of government intervention in their economies: they have made different value judgements!
THAT'S THE END OF ECON 101!
HERE IS THE TAKE HOME MESSAGE:
1: Assume nothing. Why? Well, economics is all about putting together arguments. In order to make a good argument, you need to get rid of your assumptions, don't jump to conclusions, and evaluate the evidence clearly for yourself. Make sure your arguments are based on observable, provable facts, and not sound-bites which you've picked up from different sources.
2: Rational Wisdom: Using your smarts with a broader perspective!
-You're at least as smart as the next person. There's even the chance that you might be smarter.
-There are benefits to this: we probably get to become important people.
-On the other hand, you must use your smarts with humility and responsibility. Don't be arrogant- instead use your powers for good.
Congratulations on finishing Econ. It's study time. If you read these notes at all, share them with your friends. I'm probably going to be organizing some small scale, not-for-profit review sessions for anyone who's interested over the next couple of weeks. I'll be making a post here as soon as I've got times and dates figured out for that.
Wednesday, December 2, 2009
Government Intervention: When Markets Fail
WHAT IS THE BASIC FUNCTION OF THE GOVERNMENT?
-The government has a monopoly on violence, in order to keep society from dissolving into violent anarchy (in countries where the government does not have a monopoly on violence, anarchy and civil unrest make like very difficult- just think of Somalia, or Afghanistan)
-Because the government has this monopoly on violence, they can enforce property rights laws, and prevent people for stealing other people's property
-The government's main job from an economist's perspective, then, is to enforce property rights
-By enforcing property rights and maintaining stability, governments allow for economic activity and prosperity.
OKAY!
So, for most of this course, we have been focusing on how the market works. In most of the cases we have explored, an economy regulated by the invisible hand of the market leads to the best possible outcome for society. This chapter will examine certain situations where markets fail to provide the best possible outcome for society, and how the government can intervene to correct this. We're also going to look at some inherent problems with government intervention.
Basically, when looking at any economic situation, we should ask ourselves:
-"Is the market working or failing"
-"If the market is failing, what is the optimal level of government
Markets are working best when they are allocatively efficient. Competitive markets are allocatively efficient:
-Competitive Markets use marginal cost pricing, so the price is set at the marginal cost of producing the last unit
-Competitive Markets minimize price and maximize the quantity produced
-Competitive Markets maximize economic surplus
If all markets were perfectly competitive, then the economy would be allocatively efficient. This is a pareto optimum, and neither producers not consumers would be able to add to their own surplus without causing the other to lose surplus.
PROBLEM: Most markets aren't perfectly competitive!
Here is an informal defense of natural market forces- why governments should usually just let the economy run itself.
-Free markets are automatic, flexible, and decentralized
-The price system acts like an invisible hand, regulating the market: demand affects price, which in turn, affects supply.
-There is no need for inefficient, centralized planning
-The pursuit of profits stimulates innovation and economic growth
-Power is naturally challenged through competition and innovation, so it is ultimately difficult for monopolies to exist indefinitely.
-Milton Friedman argued that economic freedom is essential to political freedom (which makes sense: if you don't have enough money to afford a house or fixed address, then you can't vote).
--------------------------------
INSTANCES OF MARKET FAILURES: Sometimes we do need the government to intervene. Sometimes, intervention is a waste of public funds. Many of the services which the government provides are, according to our prof, unnecessary and wasteful.
---------------------------------
MONOPOLIES:
-Monopolies and monopolistic competition have downward-sloping demand, so they are allocatively inefficient.
-This is due to barriers to entry
-The government usually does not obliquely try to eliminate monopolies. Instead, they either punish monopolies with regulation, or they try to create a level playing field with competition policy
-Governments can intervene in monopolies to make things more allocatively efficient
EXTERNALITIES: Non-priced costs or benefits which affect third parties
-This refers to the results of economic functioning which effect people other than the buyer and the seller (for an example, if you buy a coat of paint for your house, and then paint the ugly front of your house to make it look nicer, this creates an external benefit for your neighbor, whose property values probably will increase as a result).
-EXTERNAL ECONOMIES are external benefits, such as the added benefit your neighbor receives when you paint your house
-EXTERNAL DISECONOMIES are external costs, such as pollution or second-hand smoke.
-PRIVATE COSTS are the costs to the buyer or seller (this includes opportunity cost)
-SOCIAL COSTS are the combined external costs and private costs of any economic decision. This is the opportunity cost to society.
Externalities create unrecorded discrepancies between private costs and social costs, and result in allocative inefficiencies on a societal level
Negative externalities can be treated like an extra cost, and thus shift supply to the left!
This means that when there are negative externalities which are not taken into account, usually an economy is overproducing at too low a price. By raising prices and scaling back production, these economies can become allocatively efficient
Positive externalities can be treated like an addition to demand, and this they shift demand to the right!
This means that when there are positive externalities which are not taken into account, usually an economy is underproducing at too low a price. By increasing production and raising prices, these economies can become allocatively efficient.
Governments can correct externalities by forcing corporations to pay for negative externalities as an added cost.
APPLICATIONS OF EXTERNALITIES:
Here are some negative externalities which are fairly well known
-Nuisance externalities (pollution is considered a nuisance in legal terms)
-Open access resources (eg: fish in the Fraser river. There is a negative externality, in that catching the fish depletes fish stocks and reduces the availability of fish in the future).
-Congestion of highways (The fact that cars take up space on the highway is not taken into account, so even though it doesn't cost to use the highway, a negative externality is created from the frustration and irritation of having to deal with too many extra drivers)
-A famous example is the tragedy of the commons. In olden days when peasants still had commons land where they could let their animals graze, many peasants failed to take into account the cost of maintaining the grass and animal food supply of the commons. As a result, they overused the commons, and eventually all of the natural animal food become depleted, so the livestock died of starvation. This is an example of overproduction (overuse of the commons) due to a failure to factor external diseconomies into social costs.
PUBLIC GOODS: Sometimes, governments must intervene in order to provide society with a specific kind of good which markets cannot provide. Here are the characteristic of a pure public good:
1: It must be non rivalrous- in other words, consuming this good will not reduce the ability of others to consume this good (a good example of this is information-- gathering information from a sources does not hinder anyone else from gathering that information (unless you are stealing library books or something stupid like that)
2: Non excludability- If this good is produced, it must be a product which can be consumed equally by all- there are no restrictions in who is allowed and not allowed to use the good (so within the context of Gateman's class, the lecture itself is non-excludable. Everyone in the class is equally able to listen to the lecture and learn about economics from it). Example here include a lighthouse, or national defence.
Normal Goods: Rivalrous and Excludable-- This includes most goods which are sold on a market, such as chocolate bars, legal advice, plane tickets, etc. Governments can let markets take care of the distribution of normal goods. The market works here!
Common Property Goods: Rivalrous and Non Excludable-- This includes goods which anybody can access, despite their being a limited supply of the good. Examples include camping sites, or fish stocks. Often, common property goods suffer from the tragedy of the commons, and are overused because negative externalities are not factored into private costs. The market fails due to external diseconomies here!
Psuedo Public Goods: Non-Rivalrous and Excludable-- This includes goods which do not deppreciate when consumed, but which are distributed in such a way that some people are excluded from using them. Examples include art galleries, day care, roads, public parks, education, and others. The fact that these are non-rivalrous implies that supply is always greater than demand, so this excess supply will often push the price of a quasi public good down to zero. Often, the government provides these as merit goods. The market fails due to $0 price demanded, here!
Pure Public Goods: Non-Rivalrous and Non Excludable-- These are goods which do not deppreciate with use, and which are accessible to everyone. This includes things like national defence, a ligthouse signal, public information, and public protection. The free rider problem means than consumers usually will not reveal their price preferences, because they would rather someone else pay for the pure public good (everyone wants a free ride). As such, the government must use taxation to force everybody to pay for this good, or else, the good will not be produced. As such, we need the government to intervene. The market fails due to the free rider effect here!
So we need the government to intervene!
ASYMMETRY OF INFORMATION: This is where the buyer and the seller have different levels of knowledge about a particular good
a MORAL HAZARD, is an example of assymetry of information where one party has the ability and incentive to shift costs onto the other party due to some special knowledge which they posess (for example, a car mechanic could trick you into getting expensive work done on your car which you don't need). Another example is a used car salesman inflating the price of a used car.
ADVERSE SELECTION is an example of assymetry of information where "self selection" adverse affects the group. Because people who are poor drivers are more likely to purchase insurance, and isurance companies often have no way of evaluating each customer's driving abilities, poor drivers increase the overall cost of insurance at the expense of good drivers. Similarly, people who are unhealthy pay the same medical premiums as everyone else, yet cost the medical system much more money. Here, there are negative externalities created by adverse selection. The private cost to a smoker for using the hospital is less than the social cost of that hospital visit.
THE PRINCIPLE AGENT PROBLEM: Where top employees for a company seek to maximize revenues (and their own salaries) at the expense of net profits. Here, marginal social benefits and marginal social costs are not equated, so the firm is inefficient.
THUS WE HAVE A CASE FOR GOVERNMENT INTERVENTION
OTHER SOCIAL GOALS: Sometimes, governments seek to intervene for reasons other than market failures! Here are some of them
-Income redistribution (many people think this a fairer way of allocating wealth. Professor Gateman thinks its just a throwback to communism)
-Merit Goods: The government provides goods which are not pure public goods based on their Merit to society (eg: Healthcare and education). They cold technically also be provided by private groups.
-Social obligations (eg: jury duty, conscription, voting, etc.)
-Economic Growth (research and developement)
That's all for now!
-The government has a monopoly on violence, in order to keep society from dissolving into violent anarchy (in countries where the government does not have a monopoly on violence, anarchy and civil unrest make like very difficult- just think of Somalia, or Afghanistan)
-Because the government has this monopoly on violence, they can enforce property rights laws, and prevent people for stealing other people's property
-The government's main job from an economist's perspective, then, is to enforce property rights
-By enforcing property rights and maintaining stability, governments allow for economic activity and prosperity.
OKAY!
So, for most of this course, we have been focusing on how the market works. In most of the cases we have explored, an economy regulated by the invisible hand of the market leads to the best possible outcome for society. This chapter will examine certain situations where markets fail to provide the best possible outcome for society, and how the government can intervene to correct this. We're also going to look at some inherent problems with government intervention.
Basically, when looking at any economic situation, we should ask ourselves:
-"Is the market working or failing"
-"If the market is failing, what is the optimal level of government
Markets are working best when they are allocatively efficient. Competitive markets are allocatively efficient:
-Competitive Markets use marginal cost pricing, so the price is set at the marginal cost of producing the last unit
-Competitive Markets minimize price and maximize the quantity produced
-Competitive Markets maximize economic surplus
If all markets were perfectly competitive, then the economy would be allocatively efficient. This is a pareto optimum, and neither producers not consumers would be able to add to their own surplus without causing the other to lose surplus.
PROBLEM: Most markets aren't perfectly competitive!
Here is an informal defense of natural market forces- why governments should usually just let the economy run itself.
-Free markets are automatic, flexible, and decentralized
-The price system acts like an invisible hand, regulating the market: demand affects price, which in turn, affects supply.
-There is no need for inefficient, centralized planning
-The pursuit of profits stimulates innovation and economic growth
-Power is naturally challenged through competition and innovation, so it is ultimately difficult for monopolies to exist indefinitely.
-Milton Friedman argued that economic freedom is essential to political freedom (which makes sense: if you don't have enough money to afford a house or fixed address, then you can't vote).
--------------------------------
INSTANCES OF MARKET FAILURES: Sometimes we do need the government to intervene. Sometimes, intervention is a waste of public funds. Many of the services which the government provides are, according to our prof, unnecessary and wasteful.
---------------------------------
MONOPOLIES:
-Monopolies and monopolistic competition have downward-sloping demand, so they are allocatively inefficient.
-This is due to barriers to entry
-The government usually does not obliquely try to eliminate monopolies. Instead, they either punish monopolies with regulation, or they try to create a level playing field with competition policy
-Governments can intervene in monopolies to make things more allocatively efficient
EXTERNALITIES: Non-priced costs or benefits which affect third parties
-This refers to the results of economic functioning which effect people other than the buyer and the seller (for an example, if you buy a coat of paint for your house, and then paint the ugly front of your house to make it look nicer, this creates an external benefit for your neighbor, whose property values probably will increase as a result).
-EXTERNAL ECONOMIES are external benefits, such as the added benefit your neighbor receives when you paint your house
-EXTERNAL DISECONOMIES are external costs, such as pollution or second-hand smoke.
-PRIVATE COSTS are the costs to the buyer or seller (this includes opportunity cost)
-SOCIAL COSTS are the combined external costs and private costs of any economic decision. This is the opportunity cost to society.
Externalities create unrecorded discrepancies between private costs and social costs, and result in allocative inefficiencies on a societal level
Negative externalities can be treated like an extra cost, and thus shift supply to the left!
This means that when there are negative externalities which are not taken into account, usually an economy is overproducing at too low a price. By raising prices and scaling back production, these economies can become allocatively efficient
Positive externalities can be treated like an addition to demand, and this they shift demand to the right!
This means that when there are positive externalities which are not taken into account, usually an economy is underproducing at too low a price. By increasing production and raising prices, these economies can become allocatively efficient.
Governments can correct externalities by forcing corporations to pay for negative externalities as an added cost.
APPLICATIONS OF EXTERNALITIES:
Here are some negative externalities which are fairly well known
-Nuisance externalities (pollution is considered a nuisance in legal terms)
-Open access resources (eg: fish in the Fraser river. There is a negative externality, in that catching the fish depletes fish stocks and reduces the availability of fish in the future).
-Congestion of highways (The fact that cars take up space on the highway is not taken into account, so even though it doesn't cost to use the highway, a negative externality is created from the frustration and irritation of having to deal with too many extra drivers)
-A famous example is the tragedy of the commons. In olden days when peasants still had commons land where they could let their animals graze, many peasants failed to take into account the cost of maintaining the grass and animal food supply of the commons. As a result, they overused the commons, and eventually all of the natural animal food become depleted, so the livestock died of starvation. This is an example of overproduction (overuse of the commons) due to a failure to factor external diseconomies into social costs.
PUBLIC GOODS: Sometimes, governments must intervene in order to provide society with a specific kind of good which markets cannot provide. Here are the characteristic of a pure public good:
1: It must be non rivalrous- in other words, consuming this good will not reduce the ability of others to consume this good (a good example of this is information-- gathering information from a sources does not hinder anyone else from gathering that information (unless you are stealing library books or something stupid like that)
2: Non excludability- If this good is produced, it must be a product which can be consumed equally by all- there are no restrictions in who is allowed and not allowed to use the good (so within the context of Gateman's class, the lecture itself is non-excludable. Everyone in the class is equally able to listen to the lecture and learn about economics from it). Example here include a lighthouse, or national defence.
Normal Goods: Rivalrous and Excludable-- This includes most goods which are sold on a market, such as chocolate bars, legal advice, plane tickets, etc. Governments can let markets take care of the distribution of normal goods. The market works here!
Common Property Goods: Rivalrous and Non Excludable-- This includes goods which anybody can access, despite their being a limited supply of the good. Examples include camping sites, or fish stocks. Often, common property goods suffer from the tragedy of the commons, and are overused because negative externalities are not factored into private costs. The market fails due to external diseconomies here!
Psuedo Public Goods: Non-Rivalrous and Excludable-- This includes goods which do not deppreciate when consumed, but which are distributed in such a way that some people are excluded from using them. Examples include art galleries, day care, roads, public parks, education, and others. The fact that these are non-rivalrous implies that supply is always greater than demand, so this excess supply will often push the price of a quasi public good down to zero. Often, the government provides these as merit goods. The market fails due to $0 price demanded, here!
Pure Public Goods: Non-Rivalrous and Non Excludable-- These are goods which do not deppreciate with use, and which are accessible to everyone. This includes things like national defence, a ligthouse signal, public information, and public protection. The free rider problem means than consumers usually will not reveal their price preferences, because they would rather someone else pay for the pure public good (everyone wants a free ride). As such, the government must use taxation to force everybody to pay for this good, or else, the good will not be produced. As such, we need the government to intervene. The market fails due to the free rider effect here!
So we need the government to intervene!
ASYMMETRY OF INFORMATION: This is where the buyer and the seller have different levels of knowledge about a particular good
a MORAL HAZARD, is an example of assymetry of information where one party has the ability and incentive to shift costs onto the other party due to some special knowledge which they posess (for example, a car mechanic could trick you into getting expensive work done on your car which you don't need). Another example is a used car salesman inflating the price of a used car.
ADVERSE SELECTION is an example of assymetry of information where "self selection" adverse affects the group. Because people who are poor drivers are more likely to purchase insurance, and isurance companies often have no way of evaluating each customer's driving abilities, poor drivers increase the overall cost of insurance at the expense of good drivers. Similarly, people who are unhealthy pay the same medical premiums as everyone else, yet cost the medical system much more money. Here, there are negative externalities created by adverse selection. The private cost to a smoker for using the hospital is less than the social cost of that hospital visit.
THE PRINCIPLE AGENT PROBLEM: Where top employees for a company seek to maximize revenues (and their own salaries) at the expense of net profits. Here, marginal social benefits and marginal social costs are not equated, so the firm is inefficient.
THUS WE HAVE A CASE FOR GOVERNMENT INTERVENTION
OTHER SOCIAL GOALS: Sometimes, governments seek to intervene for reasons other than market failures! Here are some of them
-Income redistribution (many people think this a fairer way of allocating wealth. Professor Gateman thinks its just a throwback to communism)
-Merit Goods: The government provides goods which are not pure public goods based on their Merit to society (eg: Healthcare and education). They cold technically also be provided by private groups.
-Social obligations (eg: jury duty, conscription, voting, etc.)
-Economic Growth (research and developement)
That's all for now!
Wednesday, November 25, 2009
Productive and Allocative Efficiency for different market structure
We know that there are 4 different market structures in economics.
Now we're going to explore the idea of efficiency
PRODUCTIVE EFFICIENCY:
-This is when firms minimize the cost of inputs required to produce a given number of outputs
-This is also when firms maximize the quantity of outputs given a set combination of inputs (or set amount of money to spend on inputs)
-This is maximizing the input/output ratio (the greatest bang for your buck)
-Either hold output constant and minimize inputs (in other words, get on the LRAC curve, because the LRAC shows the combination of inputs which will cost the least in order to produce any quantity of output): This is the condition needed to reach productive efficiency for individual firms
OR
-Hold inputs constant and maximize outputs (get on the Production Possibilities Boundary)
In order for the industry to reach productive efficiency, each individual firm must have the same marginal costs because if one firm has lower marginal costs, then it is more efficient for that industry to switch to favor the lower cost producer.
CONCLUSION: In order to reach the production possibilities boundary for any one industry, both individual firms and entire industries must be productively efficient
ALLOCATIVE EFFICIENCY:
-The Allocative Concept is build around the idea of Pareto Optimality: a scenario where we cannot make someone better off without making someone else worse off. The allocative concept states that it is good to reach Pareto Optimality, because there, the mix of commodities which are produced match the mix of commodities which are desired by consumers. Allocative efficiency refers to a quality of an entire industry- not just an individual firm. While there can be many productively efficient points on a production possibilities boundary, only ONE of these is allocatively efficient.
-Allocative efficiency is one definition for "the best society can do"
CONDITIONS FOR ALLOCATIVE EFFICIENCY:
-We know that consumers will buy any one product up until the marginal benefit equals the marginal cost of that product
-The marginal benefit is the marginal value of any unit of a product minus the price
-THEREFORE, consumers buy units of a product until the price is equal to the marginal cost
-Perfect competition uses MARGINAL COST PRICING
-If the marginal benefit to the consumer outweighs the marginal cost to the producer, too little is being produced from society's viewpoint
-If the marginal benefit to the consumer is smaller than the marginal cost to the producer, then too much is being produced from society's viewpoint
ALL INDUSTRIES MUST EQUATE PRICE TO MARGINAL COSTS in order to that industry to be allocatively efficient
ECONOMIC SURPLUS MAXIMIZATION:
-Economic surplus maximization is allocatively efficient because it maximizes total surplus for all members of society
-This occurs when the price is equal to the point where demand equals supply (as it will in perfect competition). Here, total economic surplus is maximized and there is no dead weight social loss
-With free markets (where demand and supply naturally reach an equilibrium), it is impossible to make either the producers or the consumers better off without hurting the other: THIS IS PARETO OPTIMUM! This is the best scenario for society!
To test for allocative efficiency, we must ensure that:
-Price is equal to marginal cost
-Total economic surplus is maximized- there is no dead weight social loss!
--------------------------
PRODUCTIVE AND ALLOCATIVE EFFICIENCY WITH A PPC Curve
ANY POINT ON THE PPC IS PRODUCTIVELY EFFICIENT, because by definition, the PPC is the maximum level of output where all inputs are fully employed and productively efficient
ONLY ONE POINT ON THE PPC IS ALLOCATIVELY EFFICIENT, because only one combination of outputs will exactly match consumer's demands. On any other point, a tradeoff could be made in order to better one group of consumers without making anyone worse off. At the one point of allocative efficiency, no one can be made better off.
It is possible to produce too much or too little of either product.
REMEMBER: If the price is lower than the marginal cost, the producer is getting ripped off. Meanwhile, if the price is higher than the marginal cost, then the consumer is getting ripped off.
-----------------
EFFICIENCY IN PERFECT COMPETITION AND MONOPOLIES
PERFECT COMPETITION
CONDITION ONE: Is each firm producing on the LRAC in the long run? YES, because in the long run, all firms in perfect competition will produce at minimum efficiency scale.
CONDITION TWO: Is the marginal cost equal for all firms? Yes, because all firms in perfect competition face the same prices, and at the MES output level, marginal cost will = the price for all firms!
As a result, no reallocation among firms can lower industry costs: Firms in perfect competition are productive efficient!
In perfect competition, firms maximize their profits by producing where the price is equal to the marginal cost (marginal cost pricing). This will guarantee Pareto Optimality if all firms are in perfect competition: Why? Because here, there is no deadweight social loss, so both consumer and producer surpluses are maximized
Any output greater than or less than QE will reduce the total sum of producer and consumer surplus
IN SUMMARY: For perfect competition,
-Firms will produce at the minimum efficiency scale, so individual firms are productively efficient
-Marginal costs are equal for all firms, so the industry is productively efficient
-Price is equal to the average cost minimum, so in the long run, firms only make normal profits
-Price = marginal cost, so this market structure is allocatively efficient
MONOPOLIES AND EFFICIENCY
Monopolies are productively efficient!
-In the long run, the monopolist will be on the long run average cost curve (although not necessarily at MES). Why? Because monopolies want to maximize their profits by minimizing costs.
-This is productively efficient
-NOTE: The long run average cost for monopolies may be abnormally high (due to high fixed costs and excess capacity)
Monopolies are not allocatively efficient in the long run!
-To maximize profits, monopolies produce where marginal revenue equals marginal costs
-BUT, marginal revenue falls much more quickly than average revenue (price) as output increases, and thus, price will be greater than the monopolist's marginal costs at the monopoly's selected output level
-Because MC < P, the consumer is getting ripped off in a monopoly, and as such, monopolies are allocatively ineffienct
P > MC
Price is higher and quantity produced is lower than it would be if that same industry was in perfect competition
There is a deadweight social loss
WHEN INDUSTRIES CARTELIZE, THERE IS A DEADWEIGHT SOCIAL LOSS
See?
Now we're going to explore the idea of efficiency
PRODUCTIVE EFFICIENCY:
-This is when firms minimize the cost of inputs required to produce a given number of outputs
-This is also when firms maximize the quantity of outputs given a set combination of inputs (or set amount of money to spend on inputs)
-This is maximizing the input/output ratio (the greatest bang for your buck)
-Either hold output constant and minimize inputs (in other words, get on the LRAC curve, because the LRAC shows the combination of inputs which will cost the least in order to produce any quantity of output): This is the condition needed to reach productive efficiency for individual firms
OR
-Hold inputs constant and maximize outputs (get on the Production Possibilities Boundary)
In order for the industry to reach productive efficiency, each individual firm must have the same marginal costs because if one firm has lower marginal costs, then it is more efficient for that industry to switch to favor the lower cost producer.
CONCLUSION: In order to reach the production possibilities boundary for any one industry, both individual firms and entire industries must be productively efficient
ALLOCATIVE EFFICIENCY:
-The Allocative Concept is build around the idea of Pareto Optimality: a scenario where we cannot make someone better off without making someone else worse off. The allocative concept states that it is good to reach Pareto Optimality, because there, the mix of commodities which are produced match the mix of commodities which are desired by consumers. Allocative efficiency refers to a quality of an entire industry- not just an individual firm. While there can be many productively efficient points on a production possibilities boundary, only ONE of these is allocatively efficient.
-Allocative efficiency is one definition for "the best society can do"
CONDITIONS FOR ALLOCATIVE EFFICIENCY:
-We know that consumers will buy any one product up until the marginal benefit equals the marginal cost of that product
-The marginal benefit is the marginal value of any unit of a product minus the price
-THEREFORE, consumers buy units of a product until the price is equal to the marginal cost
-Perfect competition uses MARGINAL COST PRICING
-If the marginal benefit to the consumer outweighs the marginal cost to the producer, too little is being produced from society's viewpoint
-If the marginal benefit to the consumer is smaller than the marginal cost to the producer, then too much is being produced from society's viewpoint
ALL INDUSTRIES MUST EQUATE PRICE TO MARGINAL COSTS in order to that industry to be allocatively efficient
ECONOMIC SURPLUS MAXIMIZATION:
-Economic surplus maximization is allocatively efficient because it maximizes total surplus for all members of society
-This occurs when the price is equal to the point where demand equals supply (as it will in perfect competition). Here, total economic surplus is maximized and there is no dead weight social loss
-With free markets (where demand and supply naturally reach an equilibrium), it is impossible to make either the producers or the consumers better off without hurting the other: THIS IS PARETO OPTIMUM! This is the best scenario for society!
To test for allocative efficiency, we must ensure that:
-Price is equal to marginal cost
-Total economic surplus is maximized- there is no dead weight social loss!
--------------------------
PRODUCTIVE AND ALLOCATIVE EFFICIENCY WITH A PPC Curve
ANY POINT ON THE PPC IS PRODUCTIVELY EFFICIENT, because by definition, the PPC is the maximum level of output where all inputs are fully employed and productively efficient
ONLY ONE POINT ON THE PPC IS ALLOCATIVELY EFFICIENT, because only one combination of outputs will exactly match consumer's demands. On any other point, a tradeoff could be made in order to better one group of consumers without making anyone worse off. At the one point of allocative efficiency, no one can be made better off.
It is possible to produce too much or too little of either product.
REMEMBER: If the price is lower than the marginal cost, the producer is getting ripped off. Meanwhile, if the price is higher than the marginal cost, then the consumer is getting ripped off.
-----------------
EFFICIENCY IN PERFECT COMPETITION AND MONOPOLIES
PERFECT COMPETITION
CONDITION ONE: Is each firm producing on the LRAC in the long run? YES, because in the long run, all firms in perfect competition will produce at minimum efficiency scale.
CONDITION TWO: Is the marginal cost equal for all firms? Yes, because all firms in perfect competition face the same prices, and at the MES output level, marginal cost will = the price for all firms!
As a result, no reallocation among firms can lower industry costs: Firms in perfect competition are productive efficient!
In perfect competition, firms maximize their profits by producing where the price is equal to the marginal cost (marginal cost pricing). This will guarantee Pareto Optimality if all firms are in perfect competition: Why? Because here, there is no deadweight social loss, so both consumer and producer surpluses are maximized
Any output greater than or less than QE will reduce the total sum of producer and consumer surplus
IN SUMMARY: For perfect competition,
-Firms will produce at the minimum efficiency scale, so individual firms are productively efficient
-Marginal costs are equal for all firms, so the industry is productively efficient
-Price is equal to the average cost minimum, so in the long run, firms only make normal profits
-Price = marginal cost, so this market structure is allocatively efficient
MONOPOLIES AND EFFICIENCY
Monopolies are productively efficient!
-In the long run, the monopolist will be on the long run average cost curve (although not necessarily at MES). Why? Because monopolies want to maximize their profits by minimizing costs.
-This is productively efficient
-NOTE: The long run average cost for monopolies may be abnormally high (due to high fixed costs and excess capacity)
Monopolies are not allocatively efficient in the long run!
-To maximize profits, monopolies produce where marginal revenue equals marginal costs
-BUT, marginal revenue falls much more quickly than average revenue (price) as output increases, and thus, price will be greater than the monopolist's marginal costs at the monopoly's selected output level
-Because MC < P, the consumer is getting ripped off in a monopoly, and as such, monopolies are allocatively ineffienct
P > MC
Price is higher and quantity produced is lower than it would be if that same industry was in perfect competition
There is a deadweight social loss
WHEN INDUSTRIES CARTELIZE, THERE IS A DEADWEIGHT SOCIAL LOSS
See?
Sunday, November 22, 2009
Game Theory Pt. 2
In Oligopolies, and in game theory, there are also sequential games. Chess is a good example of a sequential game. In sequential games, there is time-sensitive sequencing, OR simultaneous knowledge of the other player's decision by both players. As such, we use decision trees to mark off the outcomes of sequential games.
DIFFERENT PATHS: The first player to move can use BACKWARDS INDUCTION to predict which moves their opponent will make given their move. The first mover here can predict all of the outcomes, and will probably choose the "large" strategy, because they will receive 30 points in every outcome for the large scenario. Given that the first player will always choose the "large" strategy, the second mover will always choose the large strategy as well, because they prefer having 3 points to having 0.3 points. AS SUCH, we know that there is a NASH EQUILIBRIUM, because both players are playing their best strategy given the strategy of the other play. Additionally, this is Pareto, as we cannot make either player better off.
ULTIMATUM BARGAINING GAME: In an ultimatum, the first player imposes a "take it or leave it offer". For an example, lets say that my mom gives my sister a dollar. My mom tells my sister that she must take that dollar and share some of it with me, or else she will take it away. In other words, my sister will offer me a portion of the money she has received, and I can accept it, or decline it. If I reject the offer, then neither me nor my sister will get a dollar. This is the payoff tree:
SISTER will propose $X for herself, and $(1-X) for me. If I accept this offer, I will get $(1-X), and my sister gets $X. If I reject this offer, we both get nothing.
Nash Equilibrium Occurs where I accept my sister's offer (regardless of the offer). This is because I would rather get a little bit of money than no money. Neither me nor my sister has any incentive to use any strategy other than this.
WHAT SHOULD MY SISTER'S STRATEGY BE? She should offer me the smallest amount as possible, because it is to my advantage to accept ANY offer. SO...
If my sister offers me 1 cent, it is still in my best interest to accept it, because 1 cent is better than nothing. In this scenario, my sister will get to keep 99 cents, and I will get 1 cent!
ULTIMATUM BARGAINING WITH AN ACCEPTANCE THRESHOLD: This is a version of ultimatum bargaining, but here, the second mover (me) can declare a minimum acceptance threshold (Y) in advance. This changes the payoff tree.
My sister can either propose an offer greater or equal to my minimum acceptance threshold (100-X > or = Y), or lower than it (100-X < Y). If she offers me an amount equal to or greater than my minimum acceptance threshold, then I will get $1-X, and she will get $X. If she offers me an amount lower than my minimum acceptance threshold, then I will reject the offer, and we will both get nothing.
Here, Nash Equilibrium occurs where my sister accepts my minimum acceptance threshold. This is because she would rather have a little bit of money than no money. Given my minimum acceptance threshold, it is always in my sister's best interests to offer an amount which complies with it.
SO WHAT IS MY BEST STRATEGY? Well, because it is always in my sister's best interest to accept my threshold, I stand to make the most money by setting my threshold as high as possible (99 cents). If I do this, then I will make 99 cents, and my sister will only make one cent.
KIDNAPPER GAMES ARE ALSO IMPORTANT, AS ARE COMPETITIVE MARKETS, but my internet just died and deleted all of the previous crap I typed up, and I am NOT spending another hour and typing it all up again. FORGET IT!
DIFFERENT PATHS: The first player to move can use BACKWARDS INDUCTION to predict which moves their opponent will make given their move. The first mover here can predict all of the outcomes, and will probably choose the "large" strategy, because they will receive 30 points in every outcome for the large scenario. Given that the first player will always choose the "large" strategy, the second mover will always choose the large strategy as well, because they prefer having 3 points to having 0.3 points. AS SUCH, we know that there is a NASH EQUILIBRIUM, because both players are playing their best strategy given the strategy of the other play. Additionally, this is Pareto, as we cannot make either player better off.
ULTIMATUM BARGAINING GAME: In an ultimatum, the first player imposes a "take it or leave it offer". For an example, lets say that my mom gives my sister a dollar. My mom tells my sister that she must take that dollar and share some of it with me, or else she will take it away. In other words, my sister will offer me a portion of the money she has received, and I can accept it, or decline it. If I reject the offer, then neither me nor my sister will get a dollar. This is the payoff tree:
SISTER will propose $X for herself, and $(1-X) for me. If I accept this offer, I will get $(1-X), and my sister gets $X. If I reject this offer, we both get nothing.
Nash Equilibrium Occurs where I accept my sister's offer (regardless of the offer). This is because I would rather get a little bit of money than no money. Neither me nor my sister has any incentive to use any strategy other than this.
WHAT SHOULD MY SISTER'S STRATEGY BE? She should offer me the smallest amount as possible, because it is to my advantage to accept ANY offer. SO...
If my sister offers me 1 cent, it is still in my best interest to accept it, because 1 cent is better than nothing. In this scenario, my sister will get to keep 99 cents, and I will get 1 cent!
ULTIMATUM BARGAINING WITH AN ACCEPTANCE THRESHOLD: This is a version of ultimatum bargaining, but here, the second mover (me) can declare a minimum acceptance threshold (Y) in advance. This changes the payoff tree.
My sister can either propose an offer greater or equal to my minimum acceptance threshold (100-X > or = Y), or lower than it (100-X < Y). If she offers me an amount equal to or greater than my minimum acceptance threshold, then I will get $1-X, and she will get $X. If she offers me an amount lower than my minimum acceptance threshold, then I will reject the offer, and we will both get nothing.
Here, Nash Equilibrium occurs where my sister accepts my minimum acceptance threshold. This is because she would rather have a little bit of money than no money. Given my minimum acceptance threshold, it is always in my sister's best interests to offer an amount which complies with it.
SO WHAT IS MY BEST STRATEGY? Well, because it is always in my sister's best interest to accept my threshold, I stand to make the most money by setting my threshold as high as possible (99 cents). If I do this, then I will make 99 cents, and my sister will only make one cent.
KIDNAPPER GAMES ARE ALSO IMPORTANT, AS ARE COMPETITIVE MARKETS, but my internet just died and deleted all of the previous crap I typed up, and I am NOT spending another hour and typing it all up again. FORGET IT!
Thursday, November 19, 2009
Oligopolies and Game Theory
Today, we begin game theory, which is interesting and exciting- probably one of the neatest things you will learn in Microeconomics.
Oligopolies use game theory, because decision-making is strategic- it hinges on the decisions of other firms.
OLIGOPOLY CHARACTERISTICS
-Several Sellers (but not many: 2 or 3 is most common)
-They must sell a similar, but differentiated good (ie: coke and pepsi both sell soda, but they are well-differentiated. GM and Ford both sell cars, but the brands are different, as are the cars).
-Entry and exit from the industry is possible, but very very difficult
-All of the firms can act as price setters within a reasonable limit.
REASONS FOR OLIGOPOLY
1: STRATEGIC BEHAVIOR (It benefits the firms in the oligopoly industry, so firms will actively vie to maintain oligopoly conditions)
-Merger and acquisitions (bigger companies buy up smaller companies, so that in the long run, in major industries, there are only a few large companies competing)
-With fewer rivals, the remaining players reap larger profits
-This can only occur if there are substantial barriers to entry
2: NATURAL CAUSES
-Economies of Scale: Bigger, well established companies have bigger cost savings, and are more able to approach the minimum efficiency scale than newer entrants
-Economies of Scope: It is cheaper for a company to produce two products together
-Oil and gad had both economies of scale and scope working in favor of established companies, because larger firms have an advantage over smaller firms (especially in unstable economic times, when many smaller firms go under)
3: ARTIFICIAL CAUSES
-Oligopolies due to government policies
-------------------------------
GAME THEORY/STRATEGIC BEHAVIOR: Decisions that are based on what other people do. (This section will HURT your brain)
Game: A decision making process of two or more players who are interdependent. There are two different kinds of games:
a) Simultaneous Game: Where both players make their decisions are the same time (or alternately, they don't know what the other player is going to do). An example of this would be rock-paper-scissors.
b) Sequential Game: One player makes a decision, then the other player reacts (sort of like a game of chess).
Player: The decision maker/strategist. In economics, this usually refers to the firm
Strategy: An interdependent decision (for example, choosing to move a pawn or a bishop could be two different strategies: choosing to cooperate with other firms and form a cartel or or choosing to compete and try to make more profit than other firms could be two different strategies)
Payoff: The outcome of a game: profits!
TODAY: WE ARE LEARNING ABOUT SIMULTANEOUS GAMES
Here are a few different important terms:
NASH EQUILIBRIUM: When each player's best strategy is to maintain its present behavior, given the present behavior of the rival. Given the behavior of the other, both players are simultaneously playing their best strategy. Both players have a best strategy, and "my best strategy is to keep doing what I'm doing as long as you keep doing what you're doing
-Nash EQ is stable, because both firms end up in a Nash Equilibrium scenario (both players want to play their best strategy)
-Nash EQ is an equilibrium, because neither firm will benefit from departing from it (in this way, equilibrium could have nothing to do with maintaining supply and demand)
-Nash EQ is self-policing, because there is no need for group behavior to enforce it (players will naturally adopt their best strategies)
-Stable equilibrium is reached by rational non-cooperation (if both players pursue self-interests, they will reach a Nash Equilibrium)
-THE DOMINANT STRATEGY is the strategy that yields a higher payoff, regardless of the strategy of the other player!
-THE DOMINATED STRATEGY is the strategy that yields a lower payoff than an alternate strategy, regardless of the strategy of the other player. This is the strategy, which logically should never be played because it will always lead to a lower payoff than different strategies.
NOTES:
-If two players are in a game, and both are playing their dominant strategy, then there is a Nash Equilibrium
-BUT a Nash equilibrium can be reached when not ALL parties have a dominant strategy
THE PRISONER'S DILEMMA: A dilemma which faces some players in a Nash Equilibrium (so this is still a type of Nash Equilibrium). In a prisoner's dilemma scenario, both players have a dominant strategy, but if they both play their dominant strategy, the resulting payoff is lower than if they had both played their dominated strategy.
-An example of this is studying. In order to get good marks in a class, each student's dominant strategy is to study. Interestingly, if none of the students in a particular class studied and they all go abysmally low marks, then the prof would have no choice but to scale their marks up, so that the average would end up being the same as it would if all of the students had studied. In this case, each student would have gotten the same mark-payoff, but for a minimal effort.
-The prisoner's dilemma highlights the difference between the narrow self interest of individual players, and the broad collective interest of a group.
-Other examples? -Advertising, Cellphones, Everyone Standing at a concert, everyone shouting at a party, CARTELS
CARTELS ARE AN EXAMPLE OF THE PRISONER'S DILEMMA SCENARIO: If all of the firms abide by the rules set by the cartel and actually restrict their outputs as agreed, all of the firm can generate economic profit (their collective payoff is higher than if they compete)
-If one member of a cartel cheats, however, they can potentially earn even GREATER profits than if they acted according to the restrictions of the Cartel
-If all members of a Cartel cheat, however, the Cartel will break apart and all of the firms will be in competition.
YUP! difficult decisions to make for Cartel participants...
FINAL DEFINITION: PARETO OPTIMUM- "You cannot make someone better off without making someone else worse off"
-This is one concept of "the best"
-Synonyms? Allocative efficiency; Pareto Optimality; Pareto Efficiency
-EXAMPLE: I have a chocolate ice cream cone, and my friend Genya has a butterscotch ice cream cone. My favorite flavor of ice cream is butterscotch, and her favorite flavor is chocolate. Is this a scenario of Pareto Optimality?
NO!
This may be productively efficiency, but it is not allocatively efficient. We can trade our ice cream cones and BOTH of us will be better off. Let's say me and Genya trade ice cream cones. This is an example of a PARETO IMPROVEMENT
PARETO IMPROVEMENT: An action which causes someone to be better off without making someone else worse off. The opposite of a Pareto Improvement is a Pareto Dis-improvement, which is an action which makes someone worse off without causing someone else to be better off (so if a garbage truck came by and threw rotten garbage on me and Genya's ice cream cones, that would be a Pareto Disimprovement).
Pareto Optimum is ONE defition of a best-case scenario. There can also be many different Pareto optimums (for an example, if both me and Genya have rye crackers, and we both love rye crackers, that can also be a pareto optimum)
Here are some different scenarios!
1: NASH EQUILIBRIUM - BOTH DOMINANT - PARETO
HERE, Actor one's best strategy is C1, regardless of what Actor 2 does, and Actor 2's best strategy is C2, regardless of what actor one does. As such, both actor one and Actor 2 have a Dominant Strategy (C1 and C2 respectively).
This is Nash equilibrium, given the action of the other player, both players are simultaneously playing their best strategy. The Pareto Optimum here is the same as the Nash Equilibrium, as both actors get "8" points in Nash Equilibrium. You can't make either actor better off than they already are, so this is Pareto Optimum!
2: NASH EQUILIBRIUM - ONE DOMINANT -PARETO
Here, businessman M's dominant strategy is to sell meat. No matter what the other businessman does, M will have a bigger payoff is she sells meat.
Businessman P, on the other hand has no Dominant Strategy. If M sells meat, it is better for P to sell Potatoes. If M sells Potatos, P will have a bigger payoff selling meat.
NASH EQUILIBRIUM, therefore, is when M is selling meat, and P is selling potatoes. In this scenario, given the actions of either player, both players are simultaneously playing their best strategy.
Pareto Optimum is the same scenario as Nash Equilibrium here. Both players are receiving the must payoff they can receive give the situation, so there is no way to make either player better off.
3: BATTLE OF THE SEXES- DOUBLE NASH EQUILIBRIUM, NO DOMINANT STRATEGY, & PARETO
Let's say we have a nice, normal heterosexual couple. The man likes baseball, and the woman likes ballet (they follow typical gendered behavior, which is the sort of thing that nice normal heterosexual couples do). However, the man and the woman both love each other SO MUCH that they would rather be with each other and at an activity which isn't their favorite than go to their favorite activity alone.
If the man goes to the baseball game, the woman's best strategy is to go to the baseball game too. If the man goes to the ballet game, however, the lady's best strategy is to go to the ballet game, so she HAS NO DOMINANT STRATEGY.
If the woman goes to the ballet, the man's best strategy is to go with her to the ballet. If the woman goes to the baseball game, however, the man's best strategy is to choose baseball, so he HAS NO DOMINANT STRATEGY!
There are two different Nash Equilibrium Scenarios here- both the man and the lady go to a baseball game, or they both see the ballet. In either situation, each player is playing their best strategy given the actions of the other player. Here, there are two different Pareto Optimums. If the couple are at the baseball game, it IS possible to make the woman happier, but not without making the man worse off. Conversely, if the couple is at the ballet, it IS possible to make the man happier, but not without making the woman worse off. Because we cannot make either player better off without making the other one worse off, there are two Pareto Optimums.
4: CARTELS: A PRISONERS DILEMMA NASH EQUILIBRIUM: BOTH DOMINANT, BUT NOT PARETO
In Oligopolies, firms behave interdependently, so decision-making is strategic (it depends on the actions of other players). As such, firms must take the actions of their rivals into account.
The basic dilemma: Should firms cooperate and form a Cartel, or compete with one another?
If firms cooperate, the collective profits for all of the firms will be higher
If a firm decides to compete with rivals, that firm's individual profit will be higher.
Here, both player A and player B's dominant strategy is to compete! As a result, Nash equilibrium occurs when both players are competing. This is NOT pareto optimum, however, as a change to a cooperative strategy for both players would result in a Pareto Improvement (in other words, the players are in Nash Equilibrium, they can both better off without making somebody else worse off).
This is why cartels often collapse: because their dominant strategy is to cheat!
That's all
Oligopolies use game theory, because decision-making is strategic- it hinges on the decisions of other firms.
OLIGOPOLY CHARACTERISTICS
-Several Sellers (but not many: 2 or 3 is most common)
-They must sell a similar, but differentiated good (ie: coke and pepsi both sell soda, but they are well-differentiated. GM and Ford both sell cars, but the brands are different, as are the cars).
-Entry and exit from the industry is possible, but very very difficult
-All of the firms can act as price setters within a reasonable limit.
REASONS FOR OLIGOPOLY
1: STRATEGIC BEHAVIOR (It benefits the firms in the oligopoly industry, so firms will actively vie to maintain oligopoly conditions)
-Merger and acquisitions (bigger companies buy up smaller companies, so that in the long run, in major industries, there are only a few large companies competing)
-With fewer rivals, the remaining players reap larger profits
-This can only occur if there are substantial barriers to entry
2: NATURAL CAUSES
-Economies of Scale: Bigger, well established companies have bigger cost savings, and are more able to approach the minimum efficiency scale than newer entrants
-Economies of Scope: It is cheaper for a company to produce two products together
-Oil and gad had both economies of scale and scope working in favor of established companies, because larger firms have an advantage over smaller firms (especially in unstable economic times, when many smaller firms go under)
3: ARTIFICIAL CAUSES
-Oligopolies due to government policies
-------------------------------
GAME THEORY/STRATEGIC BEHAVIOR: Decisions that are based on what other people do. (This section will HURT your brain)
Game: A decision making process of two or more players who are interdependent. There are two different kinds of games:
a) Simultaneous Game: Where both players make their decisions are the same time (or alternately, they don't know what the other player is going to do). An example of this would be rock-paper-scissors.
b) Sequential Game: One player makes a decision, then the other player reacts (sort of like a game of chess).
Player: The decision maker/strategist. In economics, this usually refers to the firm
Strategy: An interdependent decision (for example, choosing to move a pawn or a bishop could be two different strategies: choosing to cooperate with other firms and form a cartel or or choosing to compete and try to make more profit than other firms could be two different strategies)
Payoff: The outcome of a game: profits!
TODAY: WE ARE LEARNING ABOUT SIMULTANEOUS GAMES
Here are a few different important terms:
NASH EQUILIBRIUM: When each player's best strategy is to maintain its present behavior, given the present behavior of the rival. Given the behavior of the other, both players are simultaneously playing their best strategy. Both players have a best strategy, and "my best strategy is to keep doing what I'm doing as long as you keep doing what you're doing
-Nash EQ is stable, because both firms end up in a Nash Equilibrium scenario (both players want to play their best strategy)
-Nash EQ is an equilibrium, because neither firm will benefit from departing from it (in this way, equilibrium could have nothing to do with maintaining supply and demand)
-Nash EQ is self-policing, because there is no need for group behavior to enforce it (players will naturally adopt their best strategies)
-Stable equilibrium is reached by rational non-cooperation (if both players pursue self-interests, they will reach a Nash Equilibrium)
-THE DOMINANT STRATEGY is the strategy that yields a higher payoff, regardless of the strategy of the other player!
-THE DOMINATED STRATEGY is the strategy that yields a lower payoff than an alternate strategy, regardless of the strategy of the other player. This is the strategy, which logically should never be played because it will always lead to a lower payoff than different strategies.
NOTES:
-If two players are in a game, and both are playing their dominant strategy, then there is a Nash Equilibrium
-BUT a Nash equilibrium can be reached when not ALL parties have a dominant strategy
THE PRISONER'S DILEMMA: A dilemma which faces some players in a Nash Equilibrium (so this is still a type of Nash Equilibrium). In a prisoner's dilemma scenario, both players have a dominant strategy, but if they both play their dominant strategy, the resulting payoff is lower than if they had both played their dominated strategy.
-An example of this is studying. In order to get good marks in a class, each student's dominant strategy is to study. Interestingly, if none of the students in a particular class studied and they all go abysmally low marks, then the prof would have no choice but to scale their marks up, so that the average would end up being the same as it would if all of the students had studied. In this case, each student would have gotten the same mark-payoff, but for a minimal effort.
-The prisoner's dilemma highlights the difference between the narrow self interest of individual players, and the broad collective interest of a group.
-Other examples? -Advertising, Cellphones, Everyone Standing at a concert, everyone shouting at a party, CARTELS
CARTELS ARE AN EXAMPLE OF THE PRISONER'S DILEMMA SCENARIO: If all of the firms abide by the rules set by the cartel and actually restrict their outputs as agreed, all of the firm can generate economic profit (their collective payoff is higher than if they compete)
-If one member of a cartel cheats, however, they can potentially earn even GREATER profits than if they acted according to the restrictions of the Cartel
-If all members of a Cartel cheat, however, the Cartel will break apart and all of the firms will be in competition.
YUP! difficult decisions to make for Cartel participants...
FINAL DEFINITION: PARETO OPTIMUM- "You cannot make someone better off without making someone else worse off"
-This is one concept of "the best"
-Synonyms? Allocative efficiency; Pareto Optimality; Pareto Efficiency
-EXAMPLE: I have a chocolate ice cream cone, and my friend Genya has a butterscotch ice cream cone. My favorite flavor of ice cream is butterscotch, and her favorite flavor is chocolate. Is this a scenario of Pareto Optimality?
NO!
This may be productively efficiency, but it is not allocatively efficient. We can trade our ice cream cones and BOTH of us will be better off. Let's say me and Genya trade ice cream cones. This is an example of a PARETO IMPROVEMENT
PARETO IMPROVEMENT: An action which causes someone to be better off without making someone else worse off. The opposite of a Pareto Improvement is a Pareto Dis-improvement, which is an action which makes someone worse off without causing someone else to be better off (so if a garbage truck came by and threw rotten garbage on me and Genya's ice cream cones, that would be a Pareto Disimprovement).
Pareto Optimum is ONE defition of a best-case scenario. There can also be many different Pareto optimums (for an example, if both me and Genya have rye crackers, and we both love rye crackers, that can also be a pareto optimum)
Here are some different scenarios!
1: NASH EQUILIBRIUM - BOTH DOMINANT - PARETO
HERE, Actor one's best strategy is C1, regardless of what Actor 2 does, and Actor 2's best strategy is C2, regardless of what actor one does. As such, both actor one and Actor 2 have a Dominant Strategy (C1 and C2 respectively).
This is Nash equilibrium, given the action of the other player, both players are simultaneously playing their best strategy. The Pareto Optimum here is the same as the Nash Equilibrium, as both actors get "8" points in Nash Equilibrium. You can't make either actor better off than they already are, so this is Pareto Optimum!
2: NASH EQUILIBRIUM - ONE DOMINANT -PARETO
Here, businessman M's dominant strategy is to sell meat. No matter what the other businessman does, M will have a bigger payoff is she sells meat.
Businessman P, on the other hand has no Dominant Strategy. If M sells meat, it is better for P to sell Potatoes. If M sells Potatos, P will have a bigger payoff selling meat.
NASH EQUILIBRIUM, therefore, is when M is selling meat, and P is selling potatoes. In this scenario, given the actions of either player, both players are simultaneously playing their best strategy.
Pareto Optimum is the same scenario as Nash Equilibrium here. Both players are receiving the must payoff they can receive give the situation, so there is no way to make either player better off.
3: BATTLE OF THE SEXES- DOUBLE NASH EQUILIBRIUM, NO DOMINANT STRATEGY, & PARETO
Let's say we have a nice, normal heterosexual couple. The man likes baseball, and the woman likes ballet (they follow typical gendered behavior, which is the sort of thing that nice normal heterosexual couples do). However, the man and the woman both love each other SO MUCH that they would rather be with each other and at an activity which isn't their favorite than go to their favorite activity alone.
If the man goes to the baseball game, the woman's best strategy is to go to the baseball game too. If the man goes to the ballet game, however, the lady's best strategy is to go to the ballet game, so she HAS NO DOMINANT STRATEGY.
If the woman goes to the ballet, the man's best strategy is to go with her to the ballet. If the woman goes to the baseball game, however, the man's best strategy is to choose baseball, so he HAS NO DOMINANT STRATEGY!
There are two different Nash Equilibrium Scenarios here- both the man and the lady go to a baseball game, or they both see the ballet. In either situation, each player is playing their best strategy given the actions of the other player. Here, there are two different Pareto Optimums. If the couple are at the baseball game, it IS possible to make the woman happier, but not without making the man worse off. Conversely, if the couple is at the ballet, it IS possible to make the man happier, but not without making the woman worse off. Because we cannot make either player better off without making the other one worse off, there are two Pareto Optimums.
4: CARTELS: A PRISONERS DILEMMA NASH EQUILIBRIUM: BOTH DOMINANT, BUT NOT PARETO
In Oligopolies, firms behave interdependently, so decision-making is strategic (it depends on the actions of other players). As such, firms must take the actions of their rivals into account.
The basic dilemma: Should firms cooperate and form a Cartel, or compete with one another?
If firms cooperate, the collective profits for all of the firms will be higher
If a firm decides to compete with rivals, that firm's individual profit will be higher.
Here, both player A and player B's dominant strategy is to compete! As a result, Nash equilibrium occurs when both players are competing. This is NOT pareto optimum, however, as a change to a cooperative strategy for both players would result in a Pareto Improvement (in other words, the players are in Nash Equilibrium, they can both better off without making somebody else worse off).
This is why cartels often collapse: because their dominant strategy is to cheat!
That's all
Monday, November 16, 2009
Introduction to Imperfect Competition
Monopolies and Perfect Competition are both fairly extreme market structures. In reality, most firms operate in conditions known as imperfect competition. There are two different kinds of imperfect competition: Monopolistic Competition and Oligopoly
THERE IS A SPECTRUM OF DIFFERENT MARKET STRUCTURES:
Monopoly---Duopoly---Oligopoly---Monopolistic Competition---Perfect Competition
Competition increases as we go to the right (with the exception of perfect competition, in which there is no competitive behavior)
Market power increases as we go to the left (remember, market power is the ability of a single firm to control the price of a good).
CANADA: A large country with a small population (but it's getting bigger).
-The large geographic area of Canada creates higher transportation costs and natural barriers to entry (for an example, atlantic fishers cannot enter the pacific fishing market, because the costs of transporting their goods to BC for sale are too high).
-Our small population causes excess capacity (in other words, most Canadian firms which only operate domestically do not get to reap the benefits of a minimum efficiency scale because demand in Canada is not high enough to warrant such a large scale of output. This is why Canada is a big proponent of free trade- Because Canadian industries must sell their goods on the international market in order to maximize profits- domestic demand is not high enough).
MONOPOLISTIC COMPETITION: A large number of small firms. (Ie: the canadian wine market, grocery stores, night clubs, restaurants)
OLIGOPOLY: A small number of large firms (Ie: banks, insurance industries, power companies)
THE INDUSTRIAL CONCENTRATION RATIO: This lets us know what fraction of total market sales (or shipments or orders or anything really) are controlled by a given number of an industries largest firms. For an example, CR4 could be the fraction of total market sales controlled by the top 4 firms of any industry.
The industrial concentration ratio is ONE indicator of market power and competition in any industry, and can help us decide whether a market is an Oligopoly, or Monopolistic Competition. AS A GENERAL RULE, HIGHER LEVELS OF MARKET CONCENTRATION IMPLY HIGHER LEVELS OF MARKET POWER. There are, however, some issues which arise when only using industrial concentration ratios as a barometer for a market.
1: It is difficult to define a relative market for any good- are we talking about domestic markets? International markets? Is a coke part of the pop market, or is it a part of the 'junk food' market, or is it part of the much larger food and beverage market?
2: Tying the degree of competitiveness in any market to the number of firms within that market can be deceptive. For an example, a market in which the CR4 = 100%, and the top four firms each control 25% of the market could still involve fierce competition between these 4 markets. In contrast, a different market's CR4 could be only 33%, but if one of those 4 largest firms controls 30% of the market, and the rest only control 1% if the market, the firm which controls 30% of the industry will be the market leader, and will effectively set the price of goods within that market, with the other firms acting as price takers. This market has a lower industrial concentration ratio, but involves much less competition.
3: The standard concentration ratio in Canada overstates the degree of industrial concentration in Canada due to the openness of the Canadian economy (because we lack trade barriers).
IMPERFECT COMPETITION: Rivalrous behavior with some market power to set a price within a range (a combination of perfect competition and monopoly). Basically, any intermediate market structure
There are 2 types of imperfect competition:
-Monopolistic Competition (involves non-strategic behavior)
-Oligopoly (involves strategic behavior)
In Imperfect Competition There Are:
-Many Sellers
-Selling a differentiated product
-Entry and exit are possible, but not easy
-Each firm acts as a price setter within a range
MARKET CHARACTERISTICS FOR IMPERFECT COMPETITION:
1: Firms select their products (each firm decides what sort of a product they are going to produce. Often this involves product differentiation, in which the producers must somehow distinguish their product from competitor products in the eyes of the consumer. This involves associating certain products with happiness, beauty or sex appeal through clever advertising. This also ensures that different products from different producers are not PERFECT substitutes for each other. For this reason, crest toothpaste is considered a different good than oral-b toothpaste).
2: Firms select their prices (The individual firms decide what price to sell their goods at... within a reasonable range with reference to supply and demand. For instance, a sock firm knows better than to try and charge consumers $400 for a pair of socks. Firms then, act as price setters and let demand determine sales. If demand changes, firms can gage this through increased or declining sales for their goods.
3: Prices are sticky in the short run (In perfect competition, prices change in response to supply and demand. In imperfect competition, however, it is much easier for firms to directly alter their output in response to changes in demand than it is to change the price of a product (ie: for vending machines, this would take considerable effort). Price DO change in the long run, but in the short run, they tend to remain the same, regardless of demand (ie: a dairy queen blizzard costs the same in winter as it does in summer).
4: Non-price competition versus price competition.
Traditionally, people believe that firms can compete in ways other than lowering the price of a good. For instance, they can
-Create funny advertisements which entice consumers to purchase their product
-Cash in on their brand appeal
-Offer additional services (real people on the help lines)
-Guarantee Quality
-Have various warrantees of guarantees
-Have contests
According to Gateman, these are all just different forms of price competition- consumers are just getting more goods (ie: a telephone line, and nice, even-tempered technicians to help with troubleshooting) for the same price. This is economically similar to lowering the price of the good- consumers can still get more for less.
5: Barriers to entry. Unlike in markets of monopolies, these are not insurmountable.
MONOPOLISTIC COMPETITION:
-Many Sellers (so sellers will ignore each others actions, and engage in non-strategic behavior)
-Differentiated Goods (So different firms try and sell their BRANDS)
-Entry and exit CAN and DO occur (like in perfect competition)
-The firms set prices within a range (prices are sticky- they tend to stay put for a while, but firms can change them if they have to [usually, in the short run, it isn't worth their trouble])
-It is different from perfect competition because of differentiated brands (thus, demand curve is downward sloping for each firm, as they each have a slightly different product)
-Different from monopolies because of entry and exit (so demand can shift!)
PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETITION: In the short run, this is similar to monopoly profits.
-In the short run, firms can enjoy economic profits.
-These profits signal other firms to enter the industry
-As more firms enter the industry, set industry demand is divided further and further amongst competing firms. The demand for each individual firm will thus DECREASE
-Once each firm is only making normal profit (when the price is tangent to average total costs--see graph above), no new firms will enter the industry.
EXCESS CAPACITY: The difference between the minimum efficiency scale and the quantity actually produced in long run equilibrium.
In perfect competition, there is no excess capacity for individual firms in the long run.
In imperfect competition, there is excess capacity for individual firms in the long run. This means that compared to perfect competition, firms in imperfect competition will produce fewer goods at higher prices. In this way, brands (what differentiates perfectly competitive markets from imperfectly competitive markets) create a deadweight social loss (when production is limited, deadweight social loss occurs).
That's all
THERE IS A SPECTRUM OF DIFFERENT MARKET STRUCTURES:
Monopoly---Duopoly---Oligopoly---Monopolistic Competition---Perfect Competition
Competition increases as we go to the right (with the exception of perfect competition, in which there is no competitive behavior)
Market power increases as we go to the left (remember, market power is the ability of a single firm to control the price of a good).
CANADA: A large country with a small population (but it's getting bigger).
-The large geographic area of Canada creates higher transportation costs and natural barriers to entry (for an example, atlantic fishers cannot enter the pacific fishing market, because the costs of transporting their goods to BC for sale are too high).
-Our small population causes excess capacity (in other words, most Canadian firms which only operate domestically do not get to reap the benefits of a minimum efficiency scale because demand in Canada is not high enough to warrant such a large scale of output. This is why Canada is a big proponent of free trade- Because Canadian industries must sell their goods on the international market in order to maximize profits- domestic demand is not high enough).
MONOPOLISTIC COMPETITION: A large number of small firms. (Ie: the canadian wine market, grocery stores, night clubs, restaurants)
OLIGOPOLY: A small number of large firms (Ie: banks, insurance industries, power companies)
THE INDUSTRIAL CONCENTRATION RATIO: This lets us know what fraction of total market sales (or shipments or orders or anything really) are controlled by a given number of an industries largest firms. For an example, CR4 could be the fraction of total market sales controlled by the top 4 firms of any industry.
The industrial concentration ratio is ONE indicator of market power and competition in any industry, and can help us decide whether a market is an Oligopoly, or Monopolistic Competition. AS A GENERAL RULE, HIGHER LEVELS OF MARKET CONCENTRATION IMPLY HIGHER LEVELS OF MARKET POWER. There are, however, some issues which arise when only using industrial concentration ratios as a barometer for a market.
1: It is difficult to define a relative market for any good- are we talking about domestic markets? International markets? Is a coke part of the pop market, or is it a part of the 'junk food' market, or is it part of the much larger food and beverage market?
2: Tying the degree of competitiveness in any market to the number of firms within that market can be deceptive. For an example, a market in which the CR4 = 100%, and the top four firms each control 25% of the market could still involve fierce competition between these 4 markets. In contrast, a different market's CR4 could be only 33%, but if one of those 4 largest firms controls 30% of the market, and the rest only control 1% if the market, the firm which controls 30% of the industry will be the market leader, and will effectively set the price of goods within that market, with the other firms acting as price takers. This market has a lower industrial concentration ratio, but involves much less competition.
3: The standard concentration ratio in Canada overstates the degree of industrial concentration in Canada due to the openness of the Canadian economy (because we lack trade barriers).
IMPERFECT COMPETITION: Rivalrous behavior with some market power to set a price within a range (a combination of perfect competition and monopoly). Basically, any intermediate market structure
There are 2 types of imperfect competition:
-Monopolistic Competition (involves non-strategic behavior)
-Oligopoly (involves strategic behavior)
In Imperfect Competition There Are:
-Many Sellers
-Selling a differentiated product
-Entry and exit are possible, but not easy
-Each firm acts as a price setter within a range
MARKET CHARACTERISTICS FOR IMPERFECT COMPETITION:
1: Firms select their products (each firm decides what sort of a product they are going to produce. Often this involves product differentiation, in which the producers must somehow distinguish their product from competitor products in the eyes of the consumer. This involves associating certain products with happiness, beauty or sex appeal through clever advertising. This also ensures that different products from different producers are not PERFECT substitutes for each other. For this reason, crest toothpaste is considered a different good than oral-b toothpaste).
2: Firms select their prices (The individual firms decide what price to sell their goods at... within a reasonable range with reference to supply and demand. For instance, a sock firm knows better than to try and charge consumers $400 for a pair of socks. Firms then, act as price setters and let demand determine sales. If demand changes, firms can gage this through increased or declining sales for their goods.
3: Prices are sticky in the short run (In perfect competition, prices change in response to supply and demand. In imperfect competition, however, it is much easier for firms to directly alter their output in response to changes in demand than it is to change the price of a product (ie: for vending machines, this would take considerable effort). Price DO change in the long run, but in the short run, they tend to remain the same, regardless of demand (ie: a dairy queen blizzard costs the same in winter as it does in summer).
4: Non-price competition versus price competition.
Traditionally, people believe that firms can compete in ways other than lowering the price of a good. For instance, they can
-Create funny advertisements which entice consumers to purchase their product
-Cash in on their brand appeal
-Offer additional services (real people on the help lines)
-Guarantee Quality
-Have various warrantees of guarantees
-Have contests
According to Gateman, these are all just different forms of price competition- consumers are just getting more goods (ie: a telephone line, and nice, even-tempered technicians to help with troubleshooting) for the same price. This is economically similar to lowering the price of the good- consumers can still get more for less.
5: Barriers to entry. Unlike in markets of monopolies, these are not insurmountable.
MONOPOLISTIC COMPETITION:
-Many Sellers (so sellers will ignore each others actions, and engage in non-strategic behavior)
-Differentiated Goods (So different firms try and sell their BRANDS)
-Entry and exit CAN and DO occur (like in perfect competition)
-The firms set prices within a range (prices are sticky- they tend to stay put for a while, but firms can change them if they have to [usually, in the short run, it isn't worth their trouble])
-It is different from perfect competition because of differentiated brands (thus, demand curve is downward sloping for each firm, as they each have a slightly different product)
-Different from monopolies because of entry and exit (so demand can shift!)
PROFIT MAXIMIZATION FOR MONOPOLISTIC COMPETITION: In the short run, this is similar to monopoly profits.
-In the short run, firms can enjoy economic profits.
-These profits signal other firms to enter the industry
-As more firms enter the industry, set industry demand is divided further and further amongst competing firms. The demand for each individual firm will thus DECREASE
-Once each firm is only making normal profit (when the price is tangent to average total costs--see graph above), no new firms will enter the industry.
EXCESS CAPACITY: The difference between the minimum efficiency scale and the quantity actually produced in long run equilibrium.
In perfect competition, there is no excess capacity for individual firms in the long run.
In imperfect competition, there is excess capacity for individual firms in the long run. This means that compared to perfect competition, firms in imperfect competition will produce fewer goods at higher prices. In this way, brands (what differentiates perfectly competitive markets from imperfectly competitive markets) create a deadweight social loss (when production is limited, deadweight social loss occurs).
That's all
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