These lecture notes are my outline for teaching Principles of Microeconomics using Cowen / Tabarrok.

They are in need of a lot of work, but I share them regardless. Contact me damianbpark@gmail.com with questions September 18th 2012 - # 1
Economics 1e 1. Overview of the course a. Economics social science studying human behavior particularly the way people choose among the alternative uses of scarce resources to satisfy desires. i. Micro about personal and firm decisions ii. Macro about aggregate behavior inflation, unemployment, national income b. Notecards - name, year, where grew up, detail to help me remember you. c. Syllabus 2. Text I use the first edition of Modern Principles. a. Why does the price of the first edition drop so quickly after the 2nd is published? b. Why so many new editions w/o much changed content? c. Why dont professors see through this and use older editions? i. Some do, but we get a benefit of a new, free book fully supported with new technology, etc. ii. Who has to actually pay? 3. Why I like economics a. Delta: SFOCVG vs DCA (10/2/12)/BOS (9/25/12) b. Why prohibition (1920-1933)? i. Prior to the creation in 1913 of the national income tax, about a third of Uncle Sam's annual revenue came ii. By 1920, the income tax supplied two-thirds of Uncle Sam's revenues. iii. Despite pleas throughout the 1920s by journalist H.L. Mencken and a tiny handful of other sensible people to iv.
end Prohibition, Congress gave no hint that it would repeal this folly. Prohibition appeared to be here to stay - until income-tax revenues nose-dived in the early 1930s By 1933 income tax revenues were fully 60 percent lower than in 1930. Washington got anxious for a substitute source of revenue. That source was liquor sales. from liquor taxes.

4. Math review 5. Opportunity Cost a. Value of the opportunity lost in choosing something. (The value of your next best option.) i. Important in understanding behavior people respond even though money costs have not changed ii. Recognizing tradeoffs is imperative to making good decisions b. Of attending class? Just the opportunity cost c. Of going to college? i. What would you expect to happen to college attendance compared to unemployment? ii. Spikes when unemployment is high d. Of a farmer producing cotton? i. What happens if the price of corn increases? e. Of a farmer producing cotton near a city? i. Now, the OC includes the chance to build houses on the property. As the price of urban land increases, growing cotton becomes costlier and costlier even though farming itself is no more costly

f.

Of producing food? i. Producing other things we want 1. I couldnt teach. ii. Inventing new things 1. While I sit at home, I dream of new things, like TV, or cars, or planes, or Wal-Marts, smartphones, etc. iii. As we become more and more skilled at food production, we devote fewer and fewer resources to providing food leads to prosperity g. Of water pumped out of the Delta?

September 20th 2012 - # 2

Economics 1e Prof. Damian Park Outline Math Review scores mixed if you did poorly, go to the tutoring center or see me in office hours. Opportunity Cost Trade Opp Cost 1. Important in understanding behavior people respond even though money costs have not changed a. Sell farmland if the OC gets large / Switch to corn even if cotton prices flat 2. Recognizing tradeoffs is imperative to making good decisions a. Football teams overlook this (I think) 4th and goal go for it not only gets a chance for 7 points, but also if you fail, the other team has the ball deep in their own territory. b. Tax increment financing politicians believe that property tax revenues are free here, but they have an opportunity cost of less money to schools c. I find it really important in commuting its tempting to carpool because its cheaper than Amtrak, but this is focusing solely on the financial cost. I also lose time to work when carpooling, and therefore make a bad decision if I choose what is financially cheaper. Opportunity Cost is important in understanding why people / firms (business orgs) trade.

Trade
1. Why trade? a. To produce more by taking advantage of differences. i. I teach and trade those services to buy food. I could also cut down on my teaching time and spend time growing my own food, but urban foraging is hard. b. Two parents, living on a desert island. i. Both could look for food, both could share children supervision. ii. Or, one could do food, the other kids. This leads us to put our mind to improving the task at hand, and over time wed expect each of the people to get relatively better at one of these tasks 2. Key concept Comparative Advantage a. Motivate by example US/Mexico producing computers and shirts

b. c. What is the opportunity cost i. Of a shirt? ii. Of a computer?

b. A country has a comparative advantage in producing goods for which it has the lowest opportunity cost. (Comp. Adv = the ability to produce a good at a lower opportunity cost) c. Who has the Comp Adv i. in Computers? ii. In Shirts? d. W/o trade (autarky) - allocate 24 labor hours equally:

e. f. If Mexico specializes and produces 12 shirts, if it wants another computer, it must give up 6 shirts. However, the US, if it wants another shirt, must give up one computer. Clearly there is room for negotiation g. Is there a labor allocation which can produce more than 13 computers, 18 shirts? i. Mexico can specialize in shirts, the US can produce two more computers. Total production is 14, 22. ii. Mexico can trade 6 of them for 2 computer, and be BETTER OFF h. Draw PPFs, with orig and new consumption point. i. Unless countries are identical, it will ALWAYS be the case that one has a comparative advantage in SOMETHING. j. Trade increases productivity when trading partners exploit their comparative advantage i. A good thing trade allows us to consume more using the same amount of resources, or produce the same with fewer resources. 2. Wages a. Consumption/# workers b. Suppose price of a shirt is $100, price of a computer is $300 (consistent with trading 1:3) i. Mexico ($300*1+$100*6)/24 = 900/24=$37.50 ii. US ($300*12+$100*12)/24 = $200 c. Post-trade i. Mexico 6*$100+2*$300/24 = $50 ii. US 16*100+12*300=$216.66 d. Both countries workers are richer they can consume more e. Describe how folks are hurt in the short run they must find new jobs, but as a whole society is more productive. The people are now free to pursue something else more productive 3. Does trade destroy jobs? a. In the short-run, perhaps. i. If trade always exists, then there is never a period when free trade can appear and destroy jobs it simply never makes sense to pursue a profession in that industry in the first place ii. But if farmed shrimp from Vietnam destroy shrimp farming in TX or LA, then yes. 1. What do those farmers do? Pursue something else productive, hopefully 2. Many consumers who buy shrimp are richer the price of shrimp has fallen. 4. Discussion: Pollution havens a. Comparative advantage in polluting goods China has a comparative advantage in solar panels. Their country does not enforce environmental standards. a. Therefore, they have a comparative advantage in producing panels, and

b. It has been claimed that in a global economy, environmental regulations will be ineffective unless they are adopted/enforced by almost all countries simultaneously. The reasoning goes as follows: dirty (high-polluting) industries will simply move away from highly regulated countries and set up shop in countries with lax regulations (pollution havens), and then export their goods back to the regulated countries. Total global pollution is not reduced, but merely shifted to different countriesoften from rich to poor countries. b. Does this argument make sense and does it seem relevant? a. Consumers of course have the ultimate choice to refrain from purchasing bad panels if they want. b. Regardless, the evidence here does not support this i. Transport costs matter / proximity to final markets ii. Pollution control costs are typically a small part of total costs, and not enough to influence the relocation decision (typically) iii. Quality of Life matters too political stability, tax rates, infrastructure are typically very important in location decisions
c. Why have the effects not been greater? First, pollution-control costs are a small portion of total business costs; and second, costs are only one factor influencing business-location decisions. In addition to costs, factors as diverse as access to markets and the quality of life are important components of business-location decisions.Market size, wages, tax rates, political stability, access to the European market, and distance to the United States are some of the primary determinants of U.S. investment abroad. Finally, much pollution-control technology is embedded in modern plant designs. This means that a chemical factory built by a multinational corporation in South China will in fact look a lot like one built in West Virginia. Given these factors, most U.S. direct foreign investment continues to be in developed countries with environmental regulations comparable to our own.

5. Trade Outcome Division of knowledge a. Allows each of us to specialize in what we do best it extends the human mind, allows it to think about new ways of doing things, etc. b. As a result, very few of us are self-sufficient, and therefore none of us know how to make ordinary things the knowledge is shared among all of us c. http://www.youtube.com/watch?v=R5Gppi-O3a8 SKIP 3. Law of Increasing Marginal Opportunity Cost - How does Opportunity Cost vary as the activity increases? a. Farmer planting artichokes or blackberries where would he choose to plant the first plot of berries? b. What is the opportunity cost of planting berries there? c. Specialization drives this some inputs are better at producing certain goods d. We can present this tradeoff in a graph of the different production possibilities (PPF) e. Slope of the PPF represents? f. Why bowed-out?

Trade Outline Sept 20th 2012 Assignment Problem Set due next Thursday Read Ch 2 for Tuesday, Ch 3 for Thursday 1. Why trade? a. To produce more by taking advantage of differences. 2. Key concept Comparative Advantage d. Ex US/Mexico producing computers and shirts 1 worker per computer/shirt in the US, 12 workers per computer, 2 workers per shirt in Mexico. a. PPFs show what production combinations are POSSIBLE.

e. What is the opportunity cost i. Of a shirt in the US? In Mex? ii. Of a computer in the US? In Mex? b. A country has a comparative advantage in producing goods for which it has the lowest opportunity cost. (Comp. Adv = the ability to produce a good at a lower opportunity cost) i. Who has the Comp Advantage in Computers? In Shirts? c. Is there a labor allocation which can produce more if the countries trade? d. Trade increases productivity when trading partners exploit their comparative advantage 6. Wages with trade a. Consumption/# workers b. Both countries workers are richer they can consume more 7. Does trade destroy jobs? 8. Pollution havens c. Suppose China has a comparative advantage in solar panels because their country does not enforce environmental quality standards for solar plants. a. It has been claimed that in a global economy, environmental regulations will be ineffective unless they are adopted/enforced by almost all countries simultaneously. The reasoning goes as follows: dirty (high-polluting) industries will simply move away from highly regulated countries and set up shop in countries with lax regulations (pollution havens), and then export their goods back to the regulated countries. Total global pollution is not reduced, but merely shifted to different countriesoften from rich to poor countries. d. Does this argument make sense and is it relevant? 9. Key Trade Outcome Division of knowledge (no more self-sufficiency) 10. Realistic PPFs - Law of Increasing Marginal Opportunity Cost - How does Opportunity Cost vary as the activity increases?

Complete this chart, showing how each country gains from specialization and trade.
SUPPOSE the labor hours required for production are: THEN opportunity costs would be: SUPPOSE before trade, hours spent on each good are: THEN pre-trade production (and consumption) would be: IF Japan and the US specialized according to comparative advantage, production would be: SUPPOSE the terms of trade are 4 tons of food per car, and that trade is: Import 5 million cars Export 20 million tons Export 5 million cars THEN post-trade consumption would be: AND the gains from specialization and trade would be:

120 hours CARS U S FOOD per ton J CARS A P 50 hours A N Who has absolute advantage in cars and food? FOOD per ton per car 150 hours per car 20 hours

480 million hours 420 million hours 150 million hours

750 million hours

Import 20 million tons

Who has

World Totals:

Cars

comparative advantage in cars? In food?

Food

September 25th 2012 Expectations (i.e. Social Norms) very important for a functioning society. We drive on the right, we stay clean to prevent spreading disease, we respect private property to encourage investment. If expectations change and people no longer know what to expect, it can cause havoc this is true for our economic system (suppose you are considering expanding hiring at your business, but are unclear about medical insurance expectations for employees) or it is true with NFL Trade Recap 1. Trade is good Consider three people Damian, Sandy and Pete. Damian trades teaching services with Sandy for food/shelter. They are happy and can consume teaching plus food/shelter. 2. They are suddenly allowed to trade with a new country Ohio where uncle Pete lives. Pete actually provides teaching services for free. So Sandy and Damian can now consume the same amount of food and shelter and teaching, but Damian no longer has to work. I.E. they can consume the same amount using FEWER INPUTS. 3. Suppose Sandy still gives Damian food and shelter he is now unemployed, but not starving. He can look for other productive things to do, like coach youth sports, or research lizards in Utah, or whatever. Sandy and Damians consumption can increase even more. 4. Suppose Sandy doesnt still give Damian food/shelter. Now Sandy and Damian COULD consume more, but the gains are a bit unequal. Hopefully Damian can find something to do to trade for food. In general, jobs are a function of people, so I am hopeful. But there is no guaranteehttps://www.dropbox.com/s/808xgqr12zmx18y/BLS-LaborForce.png 5. Gains from trade the additional consumption from specializing and trading a. By specializing according to comparative advantage and then trading, both can have more of each good b. Relative price must be between the opportunity costs c. Sources of comparative advantage: resource base, skill composition of workforce, capital stock, legal environment, etc. Discussion topic: Pollution havens Demand / Supply Curves What they are, why they look the way they do, what they mean. The goal see and understand how prices are determined in markets. 1. Demand Curve Description a. Demand Curve for Oil graphical relationship between price and how much people are willing and able to pay, holding all else constant, in a given time period i. Willingness to pay curve ii. Marginal benefit curve b. Read horizontally i. At $20, people demand 25 million barrels per day c. and vertically i. The max price demanders are WTP for 25 million barrels per day is $20 per barrel. 2. Law of Demand Negative slope a. SUBSTITUTION the opportunity cost of buying something becomes too great, so as price increases, people buy less

b. Oil is not equally valuable in its Different uses (cars, jets, ashphalt) as the price of oil decreases, we use it in less and less useful ways. And vice versa. i. When the price is high power jets / ambulances. ii. When its low, use it for heat (which has other substitutes) or rubber ducks 3. Market Demand vs. Individual Demand a. Made up of individual demands, summed at the given price Price of Oil Quantity Quantity Quantity Farmer President Teacher 80 10 0 0 50 10 20 0 20 10 20 50 4. Consumer Surplus: Difference between max WTP and what you actually pay. a. Heterogeneity: Because the demand for oil is made up of different peoples consumption patterns and preferences, each person may get a diff CS. Some willing to pay a lot, some not so much. b. Entire consumer surplus is the area below the demand curve above the price. Price of Oil 80 50 20 5 Consumer Surplus Pres 0 30*10 60*10 75*10 CS Teacher 0 0 30*20=600 45*20=900 CS Farmer 0 0 0 15*50=750

September 27th 2012 Review Problem Set Demand contd. 1. Willingness to pay as a measure of the area below a demand curve (and marginal wtp) a. What does the entire area represent? i. Max WTP IF you could bargain with everyone individually b. The marginal benefit is the additional benefit from one more unit 1. Exercise: Consider a market demand curve for cake pieces (per day) of the form: Q D = 200 40P a. Graph clearly P=8-q/25 b. What is the maximum price/cake consumers are willing to pay for 150 pieces per day? 2 c. If 149 have been sold to those consumers willing to pay the most, what is the maximum amount that some consumer is willing to pay for the 150th? 2.02 2. Movement along (change in the quantity demanded) vs shifts in demand (change in demand). a. Increases in Demand - outward, up and to the right b. Decreases - inward, down, and to the left 3. Demand Shifters a. Prices of Subs natural gas on oil b. Complements price cars c. Population - India d. Income students bike, then drive e. Expectations Gas prices to rise this weekend, demand today changes f. Tastes has there been a shift in environmental preferences to consume oil? 4. What doesn't shift demand? Weather shocks in supply regions, pipeline breaks 5. worksheet 6. Supply: How much are suppliers willing and able to sell at a given price? a. Willingness to accept curve b. Marginal Opportunity Cost Curve Saudi Arabia - $2 and 8 million barrels. Iran and Iraq, $4 / barrel.
Country Production (bbl/day) 1 2 3 4 5 6 7 8 9 10 World OPEC Arab League Russia Saudi Arabia United States Iran China Canada Iraq Mexico 87,500,000 33,327,700 24,171,503 10,540,000 8,800,000 7,800,000 4,172,000 3,991,000 3,289,000 3,100,000 3,001,000
[3] [3]

Share of Cost per World % Barrel 100% 38.08% 29.71% 12.01% 7 10.06% 2 8.91% 4.77% 4.56% 3.90% 3.75% 3.56% 3.32% 3.05% 22.5 3 27.5 3

[3] [3]

United Arab Emirates 2,798,000 Brazil 2,572,000

11 12 13 14 15 16 17

Kuwait Venezuela European Union Norway Nigeria Libya Algeria Angola

2,494,000 2,472,000 2,365,000 2,350,000 2,211,000 2,210,000 2,125,000 1,948,000

2.96% 2.93% 2.81% 2.79% 2.62% 2.60% 2.52% 2.31% 5

7. Suppliers are happy to supply oil if the price is above their opportunitycost. We can trace out a supply curve. THE COST INCLUDES THE opportunity cost of ALL INPUTS. a. Saudi Arabia requires drilling and people these inputs have an opportunity cost, and to hire them into this industry requires paying them AT LEAST their opportunity cost

In Class Exercise Demand A demand curve is a graphical representation of the price-quantity relationship. The law of demand states that as price increases, the quantity demanded decreases. There are many other relationships that are important too. For the following, draw the relationship between the quantity demanded for DVDs and either the price of DVDs, income, the price of electricity and the price of a movie at a theater. Draw them for an average consumer (which could be you). DVD Price Income

Price of Electricity

Price of Movies at Theater

What happens to the income-DVD quantity relationship (graph #2 above) if the price of DVDs changes? Draw it above on the same graph. What happens to the DVD price-quantity relationship (the demand curve) if the price of going to the movies increases? Draw it above on the same graph. What happens to the demand curve if the price of DVDs falls? What are you assuming is also occurring for your answer to be true?

October 2nd 2012 Supply as Willingness to Accept 1. Redraw supply curve with S.A, Iran Iraq, Canada, etc. a. Producer Surplus Area between the supply curve and the price. Difference between price and minimum willingness to accept. i. $20/bbl==> Saudi Arabia gets $18 surplus b. Area under supply curve is the total (opportunity cost) of production i. Given we have produced 10 million barrels, what will it cost to produce another? ii. What does it cost in total to produce 10 million barrels? 2. Supply Curve Shifters How do supply curves move a. (Opportunity) Costs i. Natural Gas mining became REALLY profitable, expect more costly oil ii. Cheaper extraction technology makes it cheaper to bring oil to surface b. # Producers add another Iran, shift out curve c. Taxes i. If the government extracts $1 tax on suppliers, then it must shift up in order for suppliers to remain fairly compensated d. Expectations i. If everyone expects the oil price to increase later, you try to sell tomorrow by holding some off today 3. Price determination The point of supply and demand models. 4. Equilibrium -Define equilibrium as the intersection the point where Qs and Qd are equal. a. Equilibrium Price price which equates suppliers desires to sell with demanders desires to buy. b. Outside of the intersection point, some people want more or less than suppliers are willing to sell. i. Suppose price is below the equilibrium price. Demanders want a lot, but suppliers are not providing. They realize they can 1. Charge more 2. Buyers compete on the scarce goods. ii. What if price is above equilibrium price? 1. Suppliers happy to sell lots of oil and pump a lot, but buyers aren't buying it. There is a SURPLUS. Encourages sellers to drop their prices to sell the surplus 5. In a free market, letting folks trade leads to a phenomenal outcome a. The goods are bought by those buyers that value the good the most. b. The goods are sold by those sellers that have the lowest production costs. c. There are no more beneficial trades to be had, nor are there any wasteful trades. Diagram a wasteful trade when the government forces overproduction 6. Maximizes both producer and consumer surplus a. Producing less than the equilibrium quantity = still more beneficial trades out there b. Producing more = the cost to a producer is greater than the marginal value to consumers i. Suppose sellers were producing 95 MBD (equil 65, $30). Marginal cost>MB ii. Bus service along a standard route, a bus company may serve rush hour only. Why not expand service? 7. Iowa EM a. Polls are unreliable (sample selection, truth) b. Let people buy and sell shares of their candidate c. Buy a contract bundle

d. People trade the shares, establishing a price for Romney i. Supply = ranges from 0 to $1 based on people's WTA ii. Demand = ranges from $1 to $0 based on people's WTP e. Suppose price of Romney is $.50 but you believe there is no chance he wins f. Sell your share, make $.50 cents on Obama. i. Encourages people to put their money where their mouth is and reveal their knowledge ii. If others follow, supply shifts out...

October 4th 2012 S+D; Elasticity

1. 2.

3. Experiment when buyers and sellers interact, does one price emerge? How well does this model work in predicting prices? a. See price converge, calculate consumer surplus, producer surplus, see gains from trade, see that no more potential trades exist 4. Tax Example Bottled Water Supply and Demand Algebraic Example a. Qd = 36 - 12P b. Qs = 24P c. ?Equilibrium Price d. What happens to the price if we tax bottled water suppliers? i. Increases ii. Is it an effective way to discourage bottled water consumption? iii. Tax of $.25/bottle. iv. New supply CurveP=Q/24+.25 Q=22 P=$1.16 5. Elasticity a. changes in the price of a good will affect the amount that people want to buy or that producers want to sell. b. Measure of price responsiveness i. Flatter curves are more elastic ii. Defn = %change in Q / % change in P 1. Formula for midpoint method of calculation iii. Why relative? A dime change in the price of gasoline is more impt than a dime change in the price of tuition so we look at percentages 6. Determinants of Elasticity of Demand
a.

Review how markets determine prices for Romney and Obama Shares more suppliers push the price down In class example: Use supply and demand analysis to explain why hotel room rates near SCUs campus during parents weekend and graduation weekend might differ from the rates charged during the rest of the year. Use a graph in your answer, and justify the slopes of your curves. Think carefully about the slope of the supply curve it likely isnt constant a. Hotelier must cover opportunity cost of maid's time, energy, materials...but fairly low.

Availability of Substitutes

b.

Time Horizon The time horizon influences the elasticity of demand for a good.
i. Gas. Water. ii. Short run demand for gasoline is highly inelastic. When price rose to over $4.00 per gallon in mid 2008, quantity demanded initially decreased only slightly. In the long run, people began shifting to other types of transportation and buying more fuelefficient vehicles. Sales of SUVs declined by more than 30 percent, sales of hybrids rose over 20 percent, and ridership on mass transit rose by double digits.

i. the city of Washington, D.C. decided to raise gasoline taxes, and residents went elsewhere to buy gas; monthly gasoline sales in Washington, D.C. fell from 16 million gallons to fewer than 11 million gallons.

Mathematics of Demand Elasticity 7. An alternative approach in calculating the elasticity of demand is to use the Midpoint
Formula given by: Dq/(q2+q1)/2 / Dp/(p1+p2)/2 At 8,2 to 10,0 segmentQ changes by 2/9. P changes by 2/1 .111 At 2,8 to 0,10 segmentQ changes by 2/1 P changes by 2/9 9

a. 8. Elasticity for a demand curve is different everywhere. But when we compare two different demand curves, the flatter one is more elastic. a. Elasticities of demand are always negative b. If the absolute value of the elasticity of demand is less than one, inelastic.

c. If the absolute value of the elasticity of demand is greater than one, elastic. d. If the absolute value of the elasticity of demand is exactly equal to one, unit elastic.

October 9th 2012; Elasticity

1. 2. Section 1 Time Horizon and Demand elasticity with gas/suvs Determinants of Elasticity of Supply

a. Change in Per-Unit Costs with Increased Production i. Do costs escalate to get more? How easy is it to make more? ii. Making more toothpicks requires more wood, but they are but a small user iii. Making more gasoline requires more oil, and to get more oil, deeper wells, more exploration costs increase and it ALSO TAKES TIME b. Time Horizon i. Who thinks we are running out? Justify ii. Resource chart there is a supply response, it just takes time iii. E D is small in the SR c. Geographic Scope i. E s broccoli in SCU they could buy all they want, won't push costs up much. However, E S for California as a whole is more inelastic because we would start bidding up the price much more as we are a larger buyer.

3.

Elasticity of Demand and Total Revenue a. If the demand curve is inelastic, then revenues go up when the price goes up b. When price goes up quantity demanded goes down by a relatively smaller amount, so revenues must be higher c. Elasticity and Drug War Program

i. Elasticity of demand is small / steep curve ii. Fighting by incarceration / burning cocaine fields reduced supply iii. Drives prices up, giving more power/ revenue to suppliers still in the game, more fighting against govt iv. If it cuts back supply at all better to address demand

4. Elasticity and Water a. Farmers use a lot of water in CA b. Elasticity is low at first, but then larger over timewhy? Estimates -.5, -.79 5. Elasticity of Supply and Gun Buyback Programs
a. b. The goal is to decrease guns in circulation, which hopefully reduces crime. Suppose supply is elastic, likely the case because Washington DC is just one city out of thousands with guns, then buying them just encourages more to come in, and the price is relatively constant. It is costless for others to bring their cheap guns to sell to criminals still. Largely a failure.

October 11th 2012: Price Signals

1. 2. 3. 4. Supply+Demand Curve Review Camino a. Doesn't count Oakland As stadium not full why? a. Economists think about incentives if they could make more money, they would right? Probably not trying to make it appear empty. Problem Set Exel question help In Class Elasticity Problem

5. Prices mean something a. They are a (sometimes crude) measure of what someone must give up to provide you the good. I.e. a measure of the opportunity cost to society b. There are TWO key parts to a purchase decision i. 1) Prices force us to think about how much we value the good. ii. 2) Prices are not random they reflect the value of the good in its alternative use iii. We give it up if our value is not as large 1. Airline tickets someone else must need to go to a funeral perhaps 2. If you buy wild mushrooms you are buying someone's labor which they could be using to do something else. They must give up $20 worth of an activity 3. My wedding cake I will pay $2.50 per slice which represents the opportunity cost of the resources involved in production the labor that might be used instead for biking recreationally, the ingredients that might be used for animal feed She must give up $2.50/slice worth of resources to make my cake And what happens if she is good but not very efficient at her job? What if her alternative activity is lawyering which she gets paid a lot. Can she charge more to reflect that her opportunity costs are higher? Maybe, but competition tends to drive prices down. 6. Problems arise when there are no price signals a. Water Ex: i. There is no market for water in CA essentially. Therefore, without prices, farmers use water in important uses and less important uses because their prices are often fairly low THERE IS NO WAY FOR THEM TO RECOGNIZE THE OPPORTUNITY COST OF THEIR ACTION. THEY ONLY COMPARE THE COST OF THE WATER TO THE VALUE TO THEMSELVES ii. If farmers were able to sell their water, they may choose to continue to farm, but at least now, they would be made aware of their opportunity cost of doing so giving up potentially hundreds of dollars per acre-foot iii. Modesto ID to SFPUC deal

b.

7. India Oil Example

October 15th: Price Signals, 1. Recycling prices? Waste of Money? a. SCU someone wtp money for AL cans, nothing for plastic cups and coffee cups. b. What can we gather from this signal? i. OC of resources used to recycle AL < Value of final product ii. Recycling plastic takes energy to collect, equipment to remanufacture it, and expertise to manage the process. These inputs are not free, 1. Why AL worth money? The positive price ($.50 / pound) indicates that someone can buy a can from you, melt it and resell the AL for enough money to come out ahead. 2. Why don't plastic cups have a positive price? It is expensive to collect, sort, clean, and remanufacture plastic. Each step takes resources. The lack of a positive price indicates that entrepreneurs cannot make money doing this, so they have no desire to buy the stuff iii. What is the goal of recycling? 1. Save landfills? No shortage of landfill space 2. Save energy? Energy in collection, etc. 3. Economize on input use? 4. Save money? 5. Recycling could be bad for the environment if goals are energy savings Might be a wash, and therefore better to spend our efforts elsewhere (like limiting packaging, if that is the goal) c. Recycling this stuff is like taking $10 and producing $5. Speculation is the attempt to profit from future price changes. a. Key point think about the marginal benefit of oil today and the marginal benefit tomorrow given two pictures of today and tomorrow how can society move oil from one time period to the next? i. Speculators may not always be correct, but they have strong incentives to be as accurate as possible because when they are wrong, they lose money. b. Expect war in middle east next year to disrupt supply.

2.

i. ii.

that there are pains today, but that things are better than if we didnt have them.

Price Ceilings : 1. Rent Control a. Draw graph b. Problem equil price is too high c. Limit market price to protect poor people? d. Result i. less Q the initial problem exacerbated by the policy reduced gains from trade (DWL loss from trades that don't get made) 1. Stop renting out spare rooms, stop subdividing homes, convert to condos, etc. 2. Prices normally provide a simple allocation method those who can pay more than the price get a unit. Those who cannot do not. a. Live w parents b. Share with more people c. Live Elsewhere ii. Tendency to push up prices with side payments iii. LL response quality, extensive applications iv. Misallocation resources 1. Someone wtp $1300 doesn't get a unit and someone wtp $725 does. a. Allow trade and both parties are better off b. Side payments can improve welfare for both sides 2. WTP is not necessarily an indicator of poverty could simply be that they are students, or have a nice parent home

October 17th 2012 Price Floors

1. Price Ceilings WTP more than it costs, so willing to wait and lose valuable time to acquire gas. i. http://www.youtube.com/watch?v=PF-NIIXDffE ii. http://www.youtube.com/watch?feature=endscreen&NR=1&v=KCOdqWZB_g @11:50 to 12:52 b. Like rent control loss in gains from trade - DWL 2. Other examples: Reductions in quality a. East german coffee - Coffee crisis, 197679 b. Due to the strong German tradition of drinking coffee, coffee imports were one of the most important for consumers. A massive rise in coffee prices in 1976/77 led to a quadrupling of the annual costs of importing coffee compared to 197275. This caused severe financial problems for the GDR, which perennially lacked hard currency. c. As a result, in the summer of 1977 the Politburo withdrew most cheaper brands of coffee from sale, limited use in restaurants, and effectively withdrew its provision in public offices and state enterprises. In addition, introduced, Mischkaffee (mixed coffee), which was 51% coffee and 49% a range of filler including chicory, rye, and sugar beet. 3. Price Floors - The minimum legal price is above the market price that would emerge naturally -Similar Effects Key is to think about the hidden / unintended consequences a. Draw labor demand and labor supply curves carefully for Jobs for the Environment i. Demand slopes down because you hire more as they are cheaper ii. Supply at some point, it doesnt make sense to work prefer to live with parents rather than go out and work a job to pay rent. People are different, so people have different RESERVATION WAGES b. Impose price ceiling of $10 / hr. puts students out of work. c. Helps some poor and middle class (majority 16-24, 223% of older workers at below poverty level, and of these , many ar enot working full time) d. Degradation in quality buy own uniforms, less snacks e. Waiting list for jobs allocate based on other factors (again) f. Unemployment - Labor is a factor of production, and making it more expensive leads to using less labor 1. SF raised minimum wage for all employees, including tipped ones. And gave them healthcare 2. Raised their cost, and many raised their prices, and SF restaurants are now relatively more expensive to nearby Oakland ones. 3. Huge boon to those that can get it though

a. Suppose your employer pays you $6/hour, and you are only worth $4. They may take away free lunches, change holiday pay structure, etc b. Mostly hits young / unskilled workers i. Walter Williams http://www.youtube.com/watch?v=7DS0XXFdyfI&feature=relmfu 4. Reason why min wage continues? Minimum wageDoesnt COST FEDs directly 5. Wasteful increases in quality a. Airlines had regulated interstate fares, in effect giving airlines a lot of money b. This led airlines to try and compete for more customers, but they could NOT COMPETE ON PRICE c. They had to charge $500 / ticket. So they began to offer really nice meals and service as a way to boost demand and compete. d. Customers liked this, but if given the chance, strongly prefer no meal and cheaper tickets = example of a bad trade
6. Who pays the tax a. Look at welfareGains from trade... b. Demand tax / Supply Tax / Supply Subsidy / Demand subsidy c. Tax i. Demand shifts willingness to pay to suppliers down ii. Supply shifts WTA from buyers up d. Subsidy i. Demand shifts total wtp up as they get a check ii. Supply shifts supply down as their WTA goes down by the subsidy amount e. In the tax case, who it is levied on DOESNT MATTER for the outcome 7. Ex: Diagram Q=-2+P Q=10-2P example = equil price>>p=$4 q=2 CS=1 PS=2 a. Tax SellersQ S =-2+(p-.5) they receive 50 cents less than the price a. Q=5/3 P=4.16 CS=69 cents PS=1.39 Tax = .83 DWL = 8 cents b. Tax consumersQ D =10-2(p+.5) they must pay 50 cents more than the price

October 22nd 2012 Subsidies; Externalities

1. Finish Algebra of when tax is placed on the buyer. 2. Ex: Diagram Q=-2+P Q=10-2P example = equil price>>p=$4 q=2 CS=1 PS=2 a. Tax SellersQ S =-2+(p-.5) they receive 50 cents less than the price a. Q=5/3 P=4.16 CS=69 cents PS=1.39 Tax = .83 DWL = 8 cents b. Tax consumersQ D =10-2(p+.5) they must pay 50 cents more than the price a. Outcome is identical who pays the tax depends on the relative elasticities of supply and demand. b. If demand is relatively more elastic, then they pay less of the tax they can escape the tax easier. 3. Subsidy a. Demand shifts total wtp up as they get a check b. Supply shifts supply down as their WTA goes down by the subsidy amount c. New equilibrium has a DWL what is this? i. Loss from producing goods where the cost of production is GREATER than the benefit. It costs to produce, yet we use it in ways that are not important. ii. Ex: Downtown Oakland has a public bus people ride it because its free, but they are hardly willing to pay anything as walking is often a better option, and regular buses also run iii. Water in CA many farmers do not pay for the capital cost of dams, and hence have subsidized water. Therefore, the water is cheaper than it otherwise would be, leading them to use it in low-valued uses (their wtp for water can be quite low) 1. Society takes many resources, combines it to produce a dam which produces water that farmers don't value that much 2. ==>they would be better off with a trade Bullet Tax likely has no effect because the supply curves and demand curves are elastic. Careful on who is the buyer, who is the supplier. Easier to ignore the middleman Buyers can easily go somewhere else Sellers Ship buillets everywhere; if Cook county pays more, they can easily bring in more bullets to sell there. Hence, elastic. Podcasts: Munger and Ice why did people clap? Should prices be allowed to fluctuate? What if competition doesnt hold them in check? Tradeoff "fairness" vs getting ice to those who need it Drugs Elasticity inelastic drugsnot much more use, but less crime by legalizing. Establish whether or not the tradeoffs are worth it to keep them illegal. (Incarceration, enforcement, lack of enforcement elsewhere, racism, murder by cops, herbicides on Colombia) vs. what? When prices send the wrong signals 1. Free markets maximize gains from trading any fewer units sold or any greater will create a loss. Therefore, the equilibrium price is efficient it maximizes the size of the pie (assuming no market failures). a. Definition: Efficient outcome is the once which maximizes total surplus. b. Sometimes free markets do not lead to the efficient outcome called a market failure 2. If the consumption or production has external non financial costs or benefits not borne by either the seller or the buyer, this is NOT true. I.E. If the actors involved face prices which DO NOT

REFLECT THE TRUE COSTS OF THEIR ACTIONS, then they receive a bad signal, and markets may not lead to the efficient outcome. a. Externality: external non financial costs or benefits inflicted upon someone other than the buyer or seller (external to the transaction). Put simply, a pecuniary externality acts through the price mechanism, while a non-pecuniary externality does not. is the effect external to the market? A rise in the price of wheat is internal to the market, and therefore I would not count it as an externality. b. Leaf blowers i. My neighbors pay for lawn care, they take all costs into account ii. However, I bear the brunt of the noise c. A bakery emits good smells which I benefit from d. A neighbor paints their house, improving the look of the neighborhood and perhaps even increasing my property value e. Neighbor burns heating oil 3. WHAT TO DO? 3 main options tax/subsidy, quantity restriction, nothing (Coase) a. Quantity Restrictions with Tradable Allowances Plant 1 2 3 Cost of SO2 $100 $200 $50 reduction/ton Electricity Units 100 50 75 Produced Tons SO2 100 50 75 Societal Cost of 60 60 60 Polution per unit Permit Rights 75 25 50 i. Goal: Reduce pollution from 225 to 150 (by 75 units) ii. Reduce emissions equally costs 25*($100+$200+$50)=$8750 iii. Grant each rights to emit equal to 25 less than they produce, but let them trade iv. Plant 1 and 2 don't reduce emissions they buy permits from 3 = TC=75*$50=3750 1. Plant 1 buys 25 permits, pays between 100 and 50 2. Plant 2 buys 25 permits, pays between 200 and 50 3. The other payments are transfers, not costs. v. Good to reduce pollution in the cheapest manner possible 1. Profits increase because COSTS fall reducing costs means that resources spent reducing pollution could be spent elsewhere 2. This is the best thing economists can offer to the debate vi. 1990 Clean Air Act amendments 1. Reduced SO 2 by 50% even as electricity generation has INCREASED 2. Clearly defined rights to pollution 3. Reduced transaction costs by distributing allowances, monitoring emissions, etc. a. Anyone could buy up permits b. Pigouvian Tax the idea is that producers do not face the true cost of what they do if they did, they wouldn't pursue quantities where the cost > benefit. i. Coal production w/ external costs adding $60 per unit ii. Firm 1 and 2 pay the tax, firm 3 abates rather than pays. Same outcome, more tax revenue. 4. Command and Control not always bad a. Smallpox eradication rather than subsidies for vaccination worked better b. If the best RESPONSE IS KNOWN, and 100% compliance is NECESSARY

5. Doing Nothing and house heating causing exhaust a. I could ask them to stop b. I could stay gone c. I could pay them d. I could move away - ++ e. If people are able to negotiate easily, most externality problems are solved meaning that if the value of him heating his home outweighs the damage done to me, then he should keep heating his home, and I should deal with it.

October 30 2012 Externalities

1. Section 2 Show graph with externality and the tax which corrects the externality. a. The supply curve represents the total cost of production, but it is private b. What if each production unit of electricity has a $ cost on other users c. Prices therefore cause a bad signal the company sees a price and produces up until its marginal cost == that, but this implies a bad tradea DWLan inefficient result. 2. Ways of attacking Climate Change through economic incentives a. If carbon has an external cost, then make users see that cost by taxing it. b. Alternatively, mandate certain things i. More efficient washers (same effectiveness now costs $900 more) ii. Low-flow toilets iii. Low carbon fuel standard / truck aerodynamics http://www.arb.ca.gov/cc/hdghg/hdghg.htm / green buildings c. Better - Tax carbon to reduce consumption send a signal that consumers can face i. Some users turn off lights, some do nothing, some insulate their pool, etc. Diverse responses to deal with new prices. But each person does what they find easiest (could be nothing). ii. TAXing - reduce consumption in ways that are LEAST COSTLY TO THEM 3. Coase Theorem if property rights are clear, trans costs are low, private bargains will ensure the market quantity is efficient even with externalities. a. It will ensure that activities don't have large externalities unless they are really that valuable. b. Cows Landowner grazing cows on land, lets them wander. He gets $200 worth or profit from doing this. They wander across a stream and eat grass of another landowner, causing $100 worth of damage (wedding site). I.E. a good trade on net for everyone. i. If property right is with rancher, then clearly he will continue to farm as he is not responsible for the damage. The wedding site owner will understand this when buying the property, and could build a fence perhaps if it was worth it to do that. ii. Interestingly, if the wedding site owner has the property right to a clean grass field, then the outcome may not be any different. He will not request that the rancher stop ranching at all. The rancher will simply compensate the wedding site for the damage as it is worth it to them to continue to allow their cows to graze. iii. Outcome is the same cows graze, cause damage, but this is efficient as the gain of $200 > $100 cost. In one case, compensated. The answer is not to ban grazing. iv. If property rights are unclear, then they will fight. 4. Positive Externalities a. Vaccines flu shots help you but also the spread of the disease i. I compare private value with private cost

ii. External benefit is therefore higher than my marginal benefit, and the quantity of vaccines consumed is too low there are unexploited gains from trade left.

November 1st 2012 - FIRMS

1. Behave rationally, like people a. People behave as if they compare the marginal opportunity cost with the marginal benefit of an action. When not behaving this way http://www.youtube.com/watch?v=_Ij_oLLL7c4 b. Firms Assume a firms goal is to maximize profits (rev Cost) 2. Also, assume we have very strong competition because a. Similar product across sellers b. Many of them OR many POTENTIAL sellers i. Cigarettes in the late 1800s before machines exhibited this just needed tobacco and rollers ii. Now, perhaps you could imagine that dog walkers are like this. 3. What Price to Set a. If you sell oil from a small well, you cannot sell for more than the world price, nor would you sell for less. b. Draw Demand and Supply determining world price ($50, 82000000 bbls), and demand for YOUR oil horizontal at the market price ($50) 4. What quantity to produce use a profit table to understand this. a. Firm borrows money to build the well, and has to pay back $30 on the loan everyday therefore, the $30 is a fixed cost of doing business. i. COSTS that DO NOT VARY with QUANTITY are fixed costs ii. To actually pump, it must pay for electricity, maintenance, storage, trucking = VARIABLE COSTS (Those that DO vary with Q) iii. VCs are rising 1. you can only get so much oil out of the well, and working it harder means not only more electricity, but more and more maintenance, but it might also remain flat for a while until capacity limit 2. labor costs increase with overtime 3. Farmers use more marginal land, self employed give up more valuable stuff, restaurants hire more cooks, and cost/quality increases with crowding, less talent.

b. Profit Table for an oil well

c. Max Profit = Max difference between TR and TC d. Also, where MR = MC i. DEFINE THEM (change in total with additional unit produced/sold) ii. MR = P in competition

iii. iv. The firm produces until the MC of its production just equals the output price 5. Average Cost Profit is Producer Surplus Fixed Costs a. Cost per barrel even though firms can be doing the best they can by producing where MC=MR doesnt imply it is doing very well we need to incorporate profits b. AC = TC/Q c. Profit = TR-TC = (P TC/Q)*Q = (P-AC)*Q = Avg profit per barrel * barrels d. This must be positive to have a positive profit

e. f. Show the Average Cost on a graph g. MC must intersect AC at the minimumaverage test scores h. What if the price of oil is $4? P=MC implies one barrel, but that means a negative profit

November 6th 2012 Average Cost

Outline Voting AC and entry/exit Quiz Firm Worksheet Assgn: Monopoly (ch 11) Salatin and Bodreaux, Problem Set Voting:

1) Iowa predicts an Obama win. 2) Ask = Why do people vote? 3) Economists think about it in the following way rationality (Mb vs mc.) a. Benefit is likely small. b. about 52 US elections (out of 16577) came down to a margin of less than 100 votes for congress from 1898-1992 c. 1 had 1-vote margin 2 had 4 vote margins1 had 5 vote margin2 had 9 vote margins - .00006 d. Only one dating back to 1898! e. Approx 1000-1300 State Rep elections (out of 40036) (1968-1989) f. 2 tied, 7 with one vote margins - .0002 4) So a. Makes sense to be ignorant about politics because the costs of knowledge are great, the benefits are what? Voting for the correct outcome, only to not matter? b. Decide based on likability (beer drinking buddy) c. Decide based on race d. Dont vote let those who care/are informed vote 5) So some people do behave this way, but many do not. Many vote w idea that they are doing their part, would feel shame, would feel terrible if it was a pivotal vote and they didn't vote, etc. They simply like voting
1. AC review the picture, show shutdown condition, derive firm's supply curve, discuss immediacy of shutdown. 2. Go through three prices P>Ac, P=AC, P<Ac, diagram profit/loss for each 3. What is the lowest price at which a firm can still make a profit? a. $17. Price must be at least greater than average cost at the minimum. 4. Economic Profit = Accounting profit-opportunity costs. Accntg Profit = Total Revenue Explicit Costs. 5. Entry and Exit Clarify Economic Profit a. Example: Paper Route 1. make $25, gas costs $5, car rental - $10 2. Accnt profit =$10

3. Econ profit takes into account opportunity costs as well a. Labor worth $10 at a night shift at a convenience store b. Econ profit = $0 you are earning enough to keep you in this industry, but not an ABNORMAL amount c. Consider instead using your own car Does your profit increase by $10? No those implicit costs must be included, and one IGNORES THEM AT THEIR OWN PERIL d. Ex: Family friend got a paper route, said they could make extra money. Didnt factor in what a lack of sleep will do, and didnt factor in what a small accident to their car would cost (both in repair and increased insurance rates) b. If P>AC, firms will be profitable, encouraging ENTRY Why? i. People and owners are compensated at their opportunity costs. If suddenly an opportunity opens up which pays them more than this, then they seek it out. ii. Suppose price of oranges increases owners of land now make more money, and others plant oranges to get a better return. iii. Apple store makes a high profit encourages others to copy them and grab a piece of this lucrative market (not quite perfectly competitive, but )

November 8th 2012 - Monopoly

1. DIVERGENCE from ZERO PROFITS DRIVES entry and exit (P=AC is the only equilibrium) a. Video stores are an exiting industry, newspapers, circuit city, solyndra http://www.bls.gov/emp/ep_table_203.htm 2. How quickly does this happen? a. When fixed costs are negligible, then profits encourage immediate entry, and losses encourage immediate exit i. Examples? Prompt ii. Driving a taxi used to be costless / haircutting iii. Now, dog walking is close to a costless entry job b. What about when fixed costs are relevant? Suppose a hotel pays rent, and has a year lease. The $100 is a fixed cost per month. If its variable costs are only $50, and revenue $75, it still makes sense to remain open because maximizing profit leads to that choice.
Decision Shut down Stay Open Fixed Costs $100 $100 Variable Costs 0 $50 Revenue 0 $75 Profit ($100) ($75)

c. In the short run (when some costs are fixed), A firm should stay open if it can cover its variable costs. i. Happy Hour Think of a restaurant open for lunch and dinner. Typically, very little business in the 3pm-6pm slot. However, cooks and managers have to be there to prep, electricity is already on, rent is paid. Costly to close down and clean, come back again. Variable costs are pretty low, so many remain open and offer happy hours which typically have reduced prices covering the cost of food plus a bit more. Food is usually simple so cooks arent burdened. ii. If you understand this, you can exploit it for your advantage. If you find a business in off-peak times, where they are low on business, you know that they prefer to charge more than the variable cost to make back some money, but given they are already operating, you may be able to make a deal for close to the variable cost. 1. Consider a shuttle driver operating an airport shuttle. If they are taking one person already, that person may be paying a high rate and covering both the fixed and variable costs. Adding you adds very little to the driver. 3. Skip - We know that the invisible hand will lead to the cheapest way of producing 200 bushels of corn, but how many bushels is the RIGHT AMOUNT? a. Entrepreneurs listen to price signals and move labor and capital into industries where they think it will be profitable to do so. b. These price signals means that some firms are always dying, some always arising. c. Creative Destruction, and it leads to more VALUE and more satisfaction of WANTS d. Above Normal Profits are TEMPORARY stand still and fall behind e. Ex: Huge influx of resources out of building housing right now as these workers and firms decide what to do with their skills, there is an adjustment time f. At the same time, resources are poured into new areas (ebook publishing, tourism services, Home health care 4. Deriving Industry Supply Curves How to move from a small MC curve to the industry supply curve? a. Constant Cost Industry

b. As the industry expands, it doesnt push up prices because its input demands (computers, labor for domain name registration) are SMALL relative to the whole, and there is easy entry other firms can enter rather cheaply. These two facts i. keep prices near average cost ii. maintain those prices even with expansion in the industry (elastic supply curve) c. Demand increases i. Price goes up as people bid more on the same number of goods ii. Each firm in the industry produces a little bit more along its MC curve as the price it sees increases iii. Firms therefore earn profits iv. Attracts new firms (few months or weeks) v. Entry doesnt stop until profits are back to 0

d. Increasing Cost Industry e. For oil extractors, if they expand output, they drive up the cost of their production because oil needs to come from tar sands, etc. (more $$$ places). Therefore, this industry is an INCREASING cost one f. AskDerive the supply curve for the two firm industry i. Two firms, one with higher Marginal and Average Costs ii. As price increases, only the first one is in business iii. Then, once price hits the breakeven point for firm 2, it enters and immediately pushes output to its profit maximizing level (no horizontal line really) iv. Price rises further, both expand along their MC curve 5. SKIP - Minimization of Total Costs of Production a. Question how to Min Cost if Farm 1 MC> Farm 2 MC? MC1=5+2Q MC2=5+Q/2 b. If each farm produces where THEIR OWN MC = Price, then the aggregate production of output will be the least costly

MONOPOLY
With competition, prices are driven down to the marginal and average cost of production for firms they produce at the minimum of their AC curve. Profits are zero. Firms are OK with this, but much prefer to get more money. Consumers of course much prefer to pay less money. Incentives created by positive profits are the same whether monopoly or perfectly competitive industry. Profits encourage entry. The difference in the case of a monopoly is that barriers prevent that entry. Examples of Monopolies:

1) 2) 3) 4) 5) 6)

Casket Sellers in Lousiana source? State law Post Office and first class mail delivery source? Federal law Drugs source? Patent law Diamonds source? Ownership of unique asset led to zirconia in 1976? Taxi Companies source? Municipal law Apple and ipad? Is it a monopoly? In a narrowly defined sense, yes. source technological innovation

Barriers to Entry A cost of producing which must be borne by a firm which seeks to enter an industry but is not borne by firms
already in the industry Something that raises the cost of a new firm entering the industry compared to existing firms Summary of Sources of Monopoly Power Patents Laws Preventing Entry Economies of Scale Hard to Duplicate Inputs Innovation GlaxoSmithKlines Patent on Combivir The Indonesian Clove Monopoly, The Algerian Wheat Monopoly, The U.S. Post Office Airlines, Subways, Cable TV, Electricity Transmission, Major Highways Oil, Diamonds, Rolex Watches Apples iPod, Mathematica Software, eBay

November 13th 2012 Monopoly contd.

. 1. How do monopolists set price? (What is the profit maximizing price?) a. Firms produce until their MC of an additional sale is equal to the marginal revenue from an additional sale 2. Demand is P=20-2Q Q=10-P/2 facing a firm a. Prompt to fill out the table with blanks everywhere except the first row P Q TR (p*q) MR 18 1 18 18 16 2 32 14 14 3 42 10 12 4 48 6 10 5 50 2 8 6 48 -2 3. Lowering price increases the revenue but also comes with a loss in revenue from cheaper prices show on graph. a. Price drops from $16 to $14 so it can sell more units it now sells 3. The revenue has dropped by $2 for 2 it was selling, but it sells an additional unit for $14. MR is the change - $14-$4 = $10. Its the change in area of the graph. 4. Monopolists produce until their MC = MR a. Assume that the industry is a constant cost industry i.e. its marginal cost curve is flat or very slightly sloped. In a competitive market, we'd assume that prices would be driven down to AC to eliminate profits. In the following picture, demand is not that great to support more than one firm. And this firm has no competition. The minimum AC point occurs far to the right in the drug business. b. Graph Demand, MR, MC, AC

c. 5. Firms that face competition cannot charge more than their marginal cost of production.

a. Firms that do not face entry competition have MARKET POWER the ability to raise price ABOVE their marginal cost without fear of other competitors entering the market 6. Costs of Monopoly Whats wrong with them? a. Producers get more, consumers get less. But from an economic perspective, that doesnt matter both are people b. In competitive markets, price is driven down to AC consumer surplus is maximized. c. Assume MC=AC (no fixed costs, constant cost industry) - Therefore, this monopolist can expand and contract at a constant cost, just like an entire constant cost industry. d. They choose to produce where MR=MC

e. f. Deadweight Loss the people who cannot afford to pay the higher price of the drug, but are willing to pay more than it costs to produce it. 7. Benefits of Monopolies a. 20 year patents allow cost recoup. 12-14 year life after FDA approval. Without this, the incentive to make new drugs would drop. b. Book has a good example about Grand Theft Auto IV it cost $100 million, and once written, the MC of the game is very low. If we forced this company to charge the marginal cost of production, it would lose its incentive to develop new games. 8. Skip - Natural Monopolies a. When a single firm can accommodate all demand at a lower cost than if two or more firms participated, they have a natural monopoly (water utility, subways (cost twice as much, same output), natural gas providers) b. The source of this condition is large fixed costs with a huge upfront investment in transmission lines and a dam, it is cheaper to have one firm providing electricity. 1. Food is perhaps the most important aspect of our health and its production has tremendous environmental impacts 2. Salatin: He cannot slaughter on farm, cannot have apprentices, cannot sell his meat on his farm once slaughtered\ w/o a license, etc. a. Zoning - mandates large slaughterhouses to protect us, results in low quality and travel b. government pasteurization in the name of safety c. Government restricts easy ways of hiring youth to work on farms with paperwork, minimum wages i. Consider 3 stone hearth unpaid internship, now paid apprenticeship due to labor laws ii. Hmong farms with family helpers now illegal iii. Volunteers on 3 stone can't do it anymore 3. What is the effect of these laws?

a. Create barriers to entry which keep out new innovators, and give market power to bigger folk, and also encourage folk to be bigger, which cause environmenta/safety problems, which lead to more regulations 4. How are we protected without these laws? a. Reputation and branding? Third party certification?

November 15th 2012 Consumer Choice

1. Review Salatin Laws how are we protected without these laws? Branding/reputation 2. Marginal Revenue Curve derivative of total revenue (ratio of change in revenue to change in quantity) 3. Boudreaux a. What is the point of monopoly regulation? To encourage competition b. Regarding Standard Oil what are some indicators that led people to call it a monopoly? i. Large market share; c. What are some behaviors that indicated it was a competitor? i. Constant cost cutting; Prices for outputs fell 4. Timeline: a. Company led by entrepreneur genius who does things differently b. Becomes giant by innovating and cutting costs (std oil w/ kerosene, MS with word processing) c. Others suffer and cannot compete, and complain to govt because they cannot understand how monopoly is doing things so cheaply d. Key Point i. Predators-that is, firms who rid themselves of tomorrow's rivals by today offering consumers such good deals that no rival can survive-look just like especially talented, determined, or energetic competitors. ii. large market share is not synonymous with monopoly power. e. Result shut down an innovative firm 5. Predatory pricing does not happen in the real world according to economists who study it a. Why? Think through the logic, explain why this doesnt make sense i. Consider entry and exit and the speed at which this happens, and think of walmart ii. Stanford driving out SCU, then raising prices leads to entry from other faculty/schools iii. Wal Mart driving out local businesses 1. Then what? Raise prices and piss people off? Which encourages entry again. And walmart must also compete with itself online and with other internet sellers in small markets. b. Absorb losses today, hopefully get prey to exit? Then what? Buy them up(For their market value, which would be similar to today's market value)? Raise prices and have new entrants enter? Uncertainty matters c. Microsoft i. Browser price is 0, MS criticized for making it too integrated, fast and cheap (bundling); Netscape users had to download it at a slow rate Because, in our view, Microsoft behaves as though it faces competition, we conclude that it does face competition. It sought efficiencies and ways of making products better it never rested on its laurels.

Consumer Choice
1. Budget Constraint. a. Budget line (or budget constraint) - the bundles of goods that can be bought if the entire budget is spent on those goods at given prices. i. If Lisa spends all her budget, Y, on clif bars and triscuits, then P c C+P T T = Y

1. Pc=1 PT=2 ii. Graph this, solving for triscuits iii. Price of triscuits changes (tax on them?), income doubles. b. Opportunity cost is the slope of the budget constraint. i. Slope = -1/2. The opp cost of a clif bar is a half box of triscuits. 2. Preferences to decide how to spend money given these constraints. a. More is better (free disposal) pt A > B if A has more than B b. (Completeness) People know what they like they can rank bundles i. Prefer A to B, B to A, B~A ii. I dont care = indifference c. Consistent Transitivity. If you prefer vanilla to strawberry, and strawberry to chocolate, you prefer vanilla to chocolate. d. Convexity people tend to prefer averages of goods rather than extremes so between two indifferent points and a line, the midpoint is preferred to the edges. i. Implies With 10 triscuits, 0- clif bars, willing to give up a large number of triscuits for one clif. ii. Diminishing marginal rate of substitution MRS XY = MU X /MU Y = negative slope of the IC

November 27th 2012 Consumer Choice contd.

Clarify Education Externality The positive effect you gain is not an externality. Your increased production is beneficial to you. But it also is good for others. Similarly, there are also negative externalities. Are they balanced? Keep in mind that most of you are going to educate yourselves regardless of any subsidy. Buit others they are in debt, they dont use their degree, etc. Is it a useful way to spend money to put these kids in college? 1. Preferences to decide how to spend money given these constraints. a. (Completeness) People know what they like they can rank bundles i. Prefer A to B, B to A, B~A ii. I dont care = indifference iii. We can draw IC curves everywhere b. More is better (free disposal) pt A > B if A has more than B i. IC Curves are downward sloping, not upward ii. Cannot be thick; farther from origin better c. Consistent Transitivity. If you prefer vanilla to strawberry, and strawberry to chocolate, you prefer vanilla to chocolate. i. IC Curves cannot cross (prove it) d. Convexity people tend to prefer averages of goods rather than extremes so between two indifferent points and a line, the midpoint is preferred to the edges. People are willing to give up more of the y-axis good when they have little of the other to get one more unit of the x-axis good. i. Implies slope decreases - Diminishing marginal rate of substitution MRS XY = MU X /MU Y = negative slope of the IC ii. When steep, it implies that With 10 triscuits, 0- clif bars, willing to give up a large number of triscuits for one clif. iii. As consumer gets more clif bars, they are willing to give up fewer triscuits for one more clif. 2. Optimization and Consumer Choice how should a consumer spend their money? a. Graphically Best affordable bundle i. Want to be on higher indifference curves. Therefore, a point of tangency leads us here. ii. At the optimum 1. Slopes of the BC must equal the slopes of the IC 2. Suppose Not - Slope of BC = -Pc/Pt = -1/2. a. @A slope is steeper than -1/2, e.g. -3. This implies that the consumer is willing to give up 3 triscuits for one clif. However, the slope of the BC says that the consumer can trade 1/3 box for 1 clif bar they only have to give up a box, but are willing to give up 3 boxes. Clearly, this point is not optimal

3. b. Introduce Utility a measure of satisfaction. Goal: (like firms) maximize utility. Constrained by income. i. Key points diminishing marginal utility assumed. ii. Consider $1 to spend. Spent on triscuits, get MU T /P T . Spent elsewhere, could get MU C /P C 1. Spent on triscruits get 1/P T . Change in utility/change in triscuits. Vice versa 2. Key is to spend such that the ratios are equal. 3. Cash or in-kind subsidy food stamps are less preferred than cash. 4. Income and Substitution Effects a. When prices go up, consumers change their consumption bundle, and we can decompose this change into two parts i. Income effect prices increaseReal income has declined 1. Holding prices constant at the new level, how much income would we have to return to the consumer to make them just as happy as before? ii. Substitution Effect change in relative prices cause a change in consumption even if your real income is held constant. 1. The difference between the income effect and the total effect b. Landsburg Imagine walking into Safeway in the candy bar aisle. i. At the old price, you buy 8 usually ii. Prices went up, now you buy only 3 iii. 5 = sum of income + sub effect iv. Hypothetical example suppose we want to isolate the income effect you feel poorer due to the price increase by a little bit. How can we make you feel richer? By giving you a little bit of money. Suppose we leave just the right amount of money on the floor (a couple quarters) and now he feels equally rich. The price increase made you feel poorer, the money makes you feel richer. Whatever happens now buy 5 candy bars is the pure substitution effect. v. Then, we could take the money back, and observe what happens put another 2 candy bars back income effect is 2. 5. Costco membership fee a. How much should Costco Charge for a Membership? i. Costco offers low prices, but you need to pay an annual membership fee. ii. Lower prices move customers to a higher indifference curve. iii. Paying a membership fee is equivalent to shifting the new budget line back. iv. The maximum fee a customer will be willing to pay is the amount that would shift the new budget line back to the old indifference curve

b. 6. Backward bending labor supply a. Leisure income tradeoff. As wage rate increases, income effect makes you consume more leisure, but sub effect works in the opposite directioin 7. Minimum income leads to less work at low income levels.

a. b. Solution? EITC, where income leaves gradually

Earnings 40,000

34,692 25,000

14,730 10,510

1500
c. 8. Demand Curve for a good Vary the price, trace out demand

4000

Leisure

November 29th 2012 Public Goods

Public goods are valuable, but markets will typically not provide them Non-excludability is the key problem if someone cannot be excluded from consumption, then there is a lack of incentive for them to contribute to the provision of the good. This means that suppliers have little incentive to provide these goods, and one solution is government taxation and provision. Other goods with negative externalities common goods have problems as well with overexploitation. Property rights may be the solution here, but they are difficult to construct. Barbed wire (lack of wood), brandingimproved property rights to the range, limited overgrazing. Examples: Contribution Game Public Goods not provided? Cleaner Air? Cleaner water? Sewage Systems that do not overflow / do not exist? 1. Markets are great at providing many goods, but some types of goods they are not so good at producing namely, those with large externalities. 2. Private Goods are excludable and rival. a. Most goods are private goods. b. Private goods can be efficiently provided in competitive markets. c. Since private goods are excludable, there is a strong incentive to pay for and thus to produce these goods. 3. Public goods non-excludable and non-rival a. Rivalry - only one person can consume the good b. Exclusion - means that others can be prevented from consuming the good. c. Therefore, demand is the vertical summation of peoples individual WTP

d.

e. f. A public good produces a positive externality, and excluding anyone from consuming a public good is inefficient. 4. Why dont markets provide them? a. Experiment see bottom 5. Free Riders a. Since public goods are non-excludable, it is difficult to get people to pay for them voluntarily. I.E. we all could be better off, but the market FAILS to get us there. I>E> there are still GAINS FROM TRADE left on the table. I.E. Inefficiency. b. NPR non-excludable, many people free ride off of them i. might provide better programming w/ more money, making people better off c. Trash Cleanup it will happen regardless of whether I help, so I prefer to consume the good, but choose not to pay d. Software Very easy to not contribute and download torrents without seeding, or get software without donating. Those that do donate allow others to freeride off of them, and if we all gave a bit more, perhaps wed have a lot more software. 6. Provision of public goods a. Taxation by government i. Forces people to contribute; can make everyone better off b. Rich people adopt first. i. They buy ipads, expensive medical procedures, new drugs. This helps fund the research that goes into development. c. Entrepreneurs constantly look for ways to provide these goods if they can profit for them (profit signals are great) i. Radio got advertising to pay for it 7. NonRival Private Goods a. Cable TV has subscription, WiFi has passwords, b. Inefficient to not allow everyone to watch given that their MB>MC, but then how would HBO make money? You could ask the government to subsidize HBO, but that is fraught with problems 8. Rival NonExcludable Goods

a. Fish in the ocean my fishing imposes an externality on others in that I catch fish that reproduce b. Tagedy of the Commons no one has the incentive to protect common resources when they dont own it themselves. Unowned propertyto shit i. Definition: The dilemma arising from the situation in which multiple individuals, acting independently and rationally consulting their own self-interest, will ultimately deplete a shared limited resource, even when it is clear that it is not in anyones long-term interest for this to happen ii. E.g. dorm kitchen, highway, grazing land, fish in the sea. c. Failure of property rights i. Maine lobstering gives fishermen right to 800 traps (non-transferable) ii. Every 5 licenses that expire upon death, only one is made available iii. Also protected eggers and juveniles d. New Zealand Fish granted ITQs but most fish were within 200 miles of their shores i. Each of the 179 Fishstocks has a total allowable catch (TAC) that is reviewed annually. TACs are set and altered to allow the stock to move towards a size that will support the maximum sustainable yield (MSY). Initial allocations of ITQs, which for most species were based on the historical catch of each qualifying individual or company over a specifc qualifying period, were made free of charge. For a number of heavily fished inshore Fishstocks the sum of the ITQs was greater than the biologically based TAC. To reduce the sum of the ITQs to the level of the TAC, a voluntary buyback scheme for quota was implemented. Government spent NZ $45 million to buy back 15 800 t of the desired catch reductions of 21 500 t. The remaining quota was removed by pro rata administrative reductions across all remaining quota holders.

Small-Class Public Goods Experiment

Overview
Contributions to the public account yield $1 to everyoneOr keep card and get $4.

The professor distributes four cards to each student: two red cards (hearts and diamonds) and two black cards (clubs and spades). The professor comes to each student and collects two cards: two red cards, two black cards, or one of each. Red cards represent the student's endowment that may be kept or contributed to a group fund. Red cards kept generate earnings only to the person holding the card. Red cards turned in (contributed) generate earnings to everyone in the group. (Black cards generate no earnings and are used to keep decisions private; when a student turns in two cards others cannot tell whether the student is turning in two red cards, two black cards, or one of each.) After all cards have been turned in, the professor counts the number of red cards contributed and announces this total to the group. Cards are returned to the students so they can make another contribution decision. After several contribution rounds, the professor announces a change in the value of red cards kept. After several more contribution rounds, students are given the opportunity to engage in a non-binding communication period before the experiment

continues. The topics that students discuss typically form the basis of the subsequent class discussion and lecture. This is a simple card game. Each of you will be given 4 cards; two of these cards are red (hearts or diamonds) and two of these cards are black (clubs or spades). All of your cards will be the same number. The exercise will consist of a number of rounds (you have 15 rounds listed on your record sheet - we will probably complete fewer than 15 rounds). When a round begins I will come to each of you in order, and you will play TWO of your four cards by placing these two cards face down on top of the stack in my hand. Your earnings in dollars are determined by what you do with your red cards. In the first several rounds: you will earn $4 for each red card that you keep and $0 for each black card that you keep. Red cards that are placed on the stack will affect everyone's earnings in the following manner. I will count up the number of red cards, and everyone will earn this number of dollars. Black cards placed on the stack have no effect on the count. When the cards are counted, I will not reveal who made which decisions, but I will return your cards to you at the end of the round (by returning to each of you in reverse order and giving you the top two cards from the stack in my hand). To summarize, your earnings for the period will be calculated as:
Earnings = $4 x (number of red cards you kept) + $1 x (total number of red cards I collect) 9.