CH.

8
Accounting Profit = Total Revenue Explicit Costs Economic Profit = Total Revenue Explicit Costs Implicit Costs Normal Profit = Implicit Costs
o If Economic Profit = 0, Normal Profit = Accounting Profit. o If Economic Profit > 0 then Normal Profit > Accounting Profit. Positive economic profits are called super-normal profits.

Two Functions of Price: o The rationing function of price: To distribute scarce goods to those consumers who value them most highly. o The allocative function of price: To direct resources away from overcrowded markets (where P is too low to cover OC) and toward markets that are underserved. Economic profits attract firms, reducing prices and profits. The long run industry equilibrium will settle at P = min ATC with the number of firms being higher. The long run industry supply curve is a horizontal straight line at minimum ATC. All long run adjustments are done through the number of firms in the industry. Economic Rent: o That part of a payment for a factor of production that exceeds the owners reservation price. o Market forces will not push economic rent to zero because inputs cannot be replicated easily. Present Value of Future Payment:

M PV (1 r )T

CH. 9
Perfect Competition: Homogeneous goods, many producers. Monopolistic Competition: Differentiated goods, many producers. o Closest to perfect competition. o A large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another. o Long-run adjustment to zero economic profits because of free entry and exit. o Importance of product differentiation.

 Oligopoly: Differentiated/homogeneous goods, few producers. o Typically more efficient than a monopoly. o Structure in which a small number of large firms produce products that are either close or perfect substitutes. Pure Monopoly: One firm. o Most inefficient. o The only supplier of a unique product with no close substitutes. Perfect competition: o If the firm raises its price, sales will be zero. o No incentive to charge a lower price because it can sell as many units as it wants at the current price. o The firms demand curve is the horizontal line at the market price. It is a price taker. Imperfect competition: o The firm has some control over price or market power. o If it raises market price, it will not lose all its customers. o If it reduces price, it will add customers. o The firm faces a downward sloping demand curve. It is a price maker. Network Economies: a products quality increases as the number of users increases. Returns to scale: o A long run phenomenon. All inputs are changed in the same proportion. o Increasing Returns to Scale: Output > doubles when inputs are doubled. Downwards sloping LRATC curve. o Decreasing Returns to Scale: Output < doubles when inputs are doubled. Upwards sloping LRATC curve. o Constant Returns to Scale: Output doubles when inputs are doubled. Horizontal LRATC curve.
o Specialization and division of labor yields efficiency. o Mass production reduces average costs (large set up costs are spread over a large amount of output). Once production is established, MC is very low. Large start-up costs. Low marginal costs. Average total cost declines sharply as output increases.

If marginal cost is constant, Marginal Cost (M) = Average Variable Cost Total cost = Fixed Cost (F) + Variable Cost (M x Q)
o Total Cost increases as output increases. o Total Cost rises at a constant rate as output rises. Upwards sloping line.

 Average Total Cost = [Fixed Cost (F) / Quantity (Q)] + Marginal Cost (M)
o Average Total Cost decreases as output increases. o Average Costs decline, and at very high levels of output ATC is infinitely close to MC. Almost the shape of 1/x

A monopolist maximizes profits by setting MR = MC o The AR is falling; so MR < AR (Average Revenue is o This implies P > MR=MC in equilibrium. Equilibrium is inefficient. A monopolists MR is less than the price this is the essential source of the monopolists power. o A monopolist that faces a highly elastic demand curve will behave a lot like a perfectly competitive industry. Under perfect price discrimination, the private profit maximizing equilibrium is exactly the socially efficient equilibrium. So, economic surplus is maximized. o All consumers willing to pay a price high enough to cover MC will be served. o Consumer surplus is zero; Economic surplus = producer surplus.

CH. 10
Dominated strategy: leads to a lower payoff than an alternative choice, regardless of the other players choices. Dominant strategy: leads to a higher payoff, regardless of the other players choice. A game is said to be in (Nash) equilibrium if each players strategy is the best he or she can choose, given the other players strategies. Prisoners dilemma: A game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy. Cartel: a coalition of firms that agrees to restrict output for the purpose of earning an economic profit. Tit-for-tat strategy: Players cooperate on the first move then mimic their partners last move on each successive move. Credible Threat: one that will be in the threateners interest to carry out once the time comes to act.

CH. 11
External Cost (negative externality): A cost of an activity that falls on people other than those who pursue the activity External Benefit (positive externality): A benefit of an activity received by people other than those who pursue the activity Positional externalities occur when an increase in one person's performance reduces the expected reward of another

CH. 12
The Free Rider Problem: An incentive problem in which too little of a good or service is produced because non-payers cannot be excluded from using it. A fair gamble is one where the expected value is zero. The Lemons Model is: o George Akerlofs (UC Berkeley, Nobel 2001) explanation as to how asymmetric information tends to reduce the average quality of goods offered for sale. The reason? o People who have below average cars (lemons), are more likely to want to sell them. o Buyers know that below average cars are more likely to be on the market and therefore will have lower reservation prices. Hence good quality cars are less likely to be sold. Statistical Discrimination: the practice of judging an individual person, good or service based on the characteristics of the group he/she belongs to. Adverse Selection: pattern in which insurance tends to be purchased disproportionately by those who are costliest for the company to insure Moral Hazard: the tendency of people to spend less effort in protecting insured property.