ManEc 300Day 1 Bryson 1. This daily outline is subject to revision and upgrading. It might be wise...

ManEc 300 Day 1Bryson

1. This daily outline is subject to revision and upgrading. It might be wise to rely on the syllabus as an agenda2. Review syllabus 3. On the significance of economics.Review Power Point presentation on the methodology and power of microeconomics

3. Personal introduction and testimony4. Feedback on concerns. What concerns do you have about ManEc 300?

ManEc 300 Day 1Bryson (Cont’d)

Course Objective I: Help you understand the firm in its competitive environment and its internal organization by mastering these concepts.

My objectives will be achieved by understanding.

Bounded rationality and private information

Central economic planning vs. markets.

Competitive markets Competitive advantage

How markets work Elasticities Isoquants and Isocost

curves Industrial regulation Isoquants and isocosts Coordination and

motivation in organizations

Mathematics and Micro-economics Market models: competition and imperfect

comp. Contracting and opportunistic behavior Performance Incentives Porter’s five competitive forces. Strategy and

Economics Production and Costs Property Rights and Ownership

Course Objective II: Help you gain the conviction through class activities that all these concepts are useful in application.

For Tomorrow’s (Second) Session

Look over syllabus Read Chap. 1, pp. 14-19, 34-39,

Chapter 3 and Chapter 4. Get accustomed to web site See online: Markets, 300.ppt


1. Make seating chart2. Discuss student presentations

(Review syllabus)3. Introduce TA for the course,

Plarent [email protected]

4. Sign up for The Wall Street Journal


Discuss markets and the market economy by reviewing concepts in “Markets, 300” Non-price variables Demand curve

Substitute products Ceteris paribus Change in supply Change in q supplied Equilibrium Surplus/shortage Consumer surplus Producer Surplus Market automaticity Government intervention


Review of first text reading assignment and Markets, 300.ppt.

Look at the end of Chapter 4, “Demand Estimation.”

Review Econometrics.ppt

For Tomorrow’s (Third) Session

Finish reading (or review) chapter 4 and brush up on elasticities

No quizzes yet. Just do the homework assignment due on Thursday.

Group 1: CEO Compensation Scott Brinkerhoff, Jason Greenwood, Rob Murtagh, Jonathan Nielsen Group 2: Intellectual Property RightsHayden Arnold, Shaun Bailey, Sunne Drinkwater, David Stevens

Group 3: K-Mart Bryan Barney, Brian Cooley, Andrea Everts,

David Jensen

TEAMS, Summer, 2004

Group 4: Microsoft as a MonopolyNathan Palki, Travy Ka Ying Wong, Sabrina Wu, Sandra Woodruff Group 5: Apple Computers and Technology Corey Davis, Aubrey Duncan, Rich Hamilton, Will Kearl

TEAMS, Summer, 2004

Team Organization

Introductions. Choose team spokesman. Exchange phone numbers, etc.

Team meeting time.

Team name?

Team Organization

Choose three issues your team would like to present. If there are no conflicts, you will be assigned your first preference.

o Choose a major firm and explain its strategies and describe its performance,

o Describe the problems of an entire industry,

o Talk about an important problem in the environment of the economy or for a particular industry

Team Organization Spokesman. Meeting time. Team name? Select presentation topic priorities:

Choose three issues to present. If there are no conflicts, you will be assigned your first choice.

o A major firm o An industry, o An important micro problem

Elasticity, Alfred Marshall

• Consumer response to price change

• ($1 off on gum/washing machine) ∆p0, ceteris paribus The Definition %∆Quantity %∆Price


Another way to write that ∆Q x 100

Q (mean)

∆P x 100

P (mean)

or, point elasticity is: η = (P/Q)(dq/dp)


%∆Quantity ∆Q x 100%∆Price Q (mean) ∆P x 100

P (mean)

P1=30

P2=40

Q1=133 Q2=200

= -[∆Q/(Q1+Q2)/2] /

[∆P/P1+P2)/2]

=-[-67/(200+133)/2] / [10/(30+40)/2]

= 1.4

or, point = (P/Q)(dq/dp)

4. Elasticity and revenues

5. Elastic >1 P TR

Inelastic <1 P TR

Unitary =1 TR max

*Diagrams showing each as well as

summary diagram


“Elastic”: >1 P TR

“Inelastic”: <1 P TR

Unitary: =1 TR maxSummary diagram

s, Elasticity of Supply%∆ in Q supplied%∆ in price

(∆Q/Q)/(∆P/P) Note positive sign

Cross of Demand% change in Q of X% change in P of Y

(∆Qx/Qx)

(∆Py/Py)+ sign: substitutes- sign: complementsCloser relationships indicated by higher coefficient

Income of Demand% change in Q of X% change in income

(∆Qx/Qx)

(∆I/I)

Q

I

negzero

lowunit

High (i>1)

For tomorrow’s (fourth) session

1. Review Power Point Presentation:Markets vs. Hierarchies (“Hierarchies”)2. Complete first homework assignment, which

is due tomorrow.

3. For subscribers, the Journal is available on line.

When it starts to come, get on line and go to http://services.wsj.com/ Enter your account number, which is on the address sticker.


See Power Point Presentation:

Markets vs. Hierarchies

(“Hierarchies”)

Day 4 For the next (5th) Session

See Power Point presentation:The Firm’s Coordination of Plans and Activities (“Firm Coordination”)

Be prepared in class to discuss or take a quiz on the following:

Should there be market coordination within the corporation?

What are design attributes? Firms don’t always have dispatchers or

coxswains, so what organizational problem do they have?

Day 4 (Cont’d) Preparation for next session

What problems of information flow does the firm have in its planning? What is brittleness?

When can the firm not rely on organizational routine for proper functioning of productive processes?

How do economies of scale and scope affect the firm’s coordination?

ManEc 300, Day 5 Review Questions from Session 4What problems of information flow does the firm have

in its planning? What is brittleness?When can the firm not rely on organizational routine

for proper functioning of productive processes?How do economies of scale and scope affect the

firm’s coordination?What problems of information flow does the firm have

in its planning? What is brittleness?When can the firm not rely on organizational routine

for proper functioning of productive processes?How do economies of scale and scope affect the

firm’s coordination?

ManEc 300 Day 5, cont.

Review “The Principle-Agent Problem” For tomorrow, you should be well into

the reading of Chapter 5 of the text.

When you get a chance, review Coase and transactions costs. (See the last part of Chapter 4 and the ppt, “Markets vs. Hierarchies”).

The Neo-classical Theory of the Firm, Part II, Production and costs.Start with an unspecified production function:

Q = f(a,b,...n) = f(X1, X2,…Xn)


A specific production function may appear as suggested in the text.

Q = S1/2 A1/2, where S = steel and A = Aluminum.Reminder: S1/2 =S and S1/n = n S


Law of Diminishing Returns: holding all inputs constant but one, increasing variable inputs will give rise first to increasing returns, but ultimately, additional units of the input will bring less than proportional returns.

Production Functions and costs.

Diminishing returns can be shown by exponents that add to less than one.

S1/2(S 1/2) = SS1/3(S 1/3) = S2/3

Production Functions and costs.

Stages of Production

Begin with a Total Product (TP) curve. With two geometric “tricks,” find Average Product (AP) and Marginal Product (MP) curves. Discuss these concepts.

Relationship between average and marginal values.

Stages of Production

At boundary of stages I/II, AP = MP, at boundary of stage II/III, MP = 0. Discuss other characteristics.

Why we produce in stage II of production.

Geometric Trick 1

Holding land constant and adding labor leads to a growth of TP until diminishing returns set in. APL = TP/labor. MPL = the change in TP when labor (a) increases by 1 unit. Geometrically, APL = TP/a or the slope of a ray from the origin, intersecting the TP curve at some level of output.

Geometric Trick 1

Land Labor TP APL MPL

1 1 1 1 1 1 1 1 1 1

0 1 2 3 4 5 6 7 8 9

0 2 5 9 12 14 15 15 14 12

0 2 2 /2 3 3 2 4/5 2 1/2 2 1/7 1 3/4 1 1/3

.. 2 3 4 3 2 1 0 -1 -2

Geometric Trick 1, the old ray from the origin trick. Slope = rise/run =

T/a APL = TP/a Draw a ray from O

through the relevant point on the TP curve.

Notice that this slope rises to point E, then falls again at larger outputs.

Geometric Trick 2, the old tangency trick.

MPa = ∆TP when we use one more unit of a.MPa = ∆TP/∆Q


Find the slope of TP ata given output to determine the MPa atat that output.. Find the slope geometrically by drawing a tangent lineto the TP curve at the interesting output.

The Stages of Production

Let us draw these and conclude by showing why we operate in

Stage II of production. In stage I, we keep going for more inputs because it results in growing average and marginal productivity. In stage III we are experiencing diminishing returns (negative MPa)

Review of Costs

1. Show: TVC, TFC, TC

What are these?

What are their slopes?


2. Review two geometric tricks:

1. Find SR: AVC, AFC, AC,

2. Find MC.

3. Relationship between average and

marginal values.


Total CostsAt first, TVC and TC rise gradually, Q rises faster than cost because of increasing returns.

Then, TVC and TC rise rapidly. Costs rise faster than output because of diminishing returns.

Average variable, average total costs

We can find the average costs from the totals, using geometric trick #1, the old ray trick.

Draw a ray from the origin through a point on the TC or TVC curve. The slope of the ray is the average cost


(Rise/Run = TC/Q = AC.

First it declines (increasing returns, then rises (diminishing returns.

Marginal Costs

Marginal cost is the change in TC or TVC when output is increased by one unit. Or, it is the slope of TC or TVC. Therefore, we can find it by taking the derivative of a TC function.

Marginal Costs

Or, we can use geometric trick #2, the old tangency trick. Draw a tangency to the TC (or TVC) curve. The slope of the tangent is MC. First, MC declines (increasing returns), but ultimately rises (decreasing returns).

Relate AVC to APP

Note that the APP rises and falls in correspondence with the decline, then increase of AVC. AP increases (AVC) falls as increasing returns to the variable factor occurs.

But as diminishing returns set in, APP falls, which means that AVC rises.

Discuss LR Costs

1. No fixed factors

2. Unlimited number of conceptual

SRAC curves

ManEc 300 Day 7Prof. Bryson (Cont’d)

Discuss LR Costs

3. Envelope curve

4. “For any output, min cost by using

the scale of plant whose SRAC curve is

tangent to the LRAC curve.”

ManEc 300 Day 7Prof. Bryson (Cont’d)

5. Why is it U-shaped?Economies of scale vs. Law of diminishing returnsEconomies of scale: division and specialization of labor, advanced technology, large machines, digitalization and electronics.Diseconomies of scale: control and coordination problems


6. Learning curve 7.

7. Four LRAC curves

Textbook U

(Range of) constant returns

Constant returns through replication

Continually increasing returns


For the next session, review pp.

111-117 on Isoquants and

Isocost lines.


Isoquant/Isocost approach to

production, trade, equilibrium and

efficiency.

ManEc 300 Episode 8Bryson

Isoquants--purpose for use

Get up to speed on diagrams.

Tight logic (and math) vs.

Scientists prize

-- skepticism,

-- rigorous reasoning, and

-- empirical experimentation.)

ManEc 300 Episode 8Bryson

Appreciate and understand

Tradeoffs

Budget constraints

Logic of maximization

Representation of efficiency

Get ready for a quiz next session on the

production box.

Learning Objectives

The analysis

1. Intuition on isoquants:

Movement NE = improvement.

Discovering substitutability of inputs.

MRTSlk = ∆ K/ ∆ L

one unit of L will compensate.

ManEc 300 Day 8 (Cont’d)

The analysis

2. Characteristics of isoquants

a. No intersection

b. Downward slope

MRTSlk = amount of K lost for which


ManEc 300 Day 8 (Cont’d)

Total Cost = C = wL + rK

Rewrite: rK = C - wL

K = C/r - (w/r)L

Intercept

ratio of factor

prices = slope of

budget line

Budget line

Slope of isoquant =

MRTSlk = MPl/MPk = ∆ K/ ∆L

Discuss diminishing MRTSlk Notion

of tradeoff

∆Q = MPl(∆L) ∆Q = MPk(∆K)

Budget line

On the isoquant

MPl (∆ L) + MPk(∆K) = 0

At equilibrium

Slope of Isoquant = Slope of isocost


Mpl /MPk = w/r

Mpl /w = MPk/r

(Mpl /Pl = Mpk/Pk)

4. Show changing slope of isocost line

5. Show changing isocost line (shift when

budget changes)


Preparation for quiz on isoquants and

the Edgeworth Box:

1. Review the effect of price changes

2. Explain the Edgeworth-Bowley Box

Trading from any point off the

contract curve to a point on the contract

curve.

3



the Edgeworth Box:

3. Gains of trade.

Efficiency is being on the contract

curve.


4. How does one move on the

contract curve?

Theft, violence, opportunism--

Elaborate according to time on

“economic man” as rational

optimizer vs. more modern

problem of opportunism.


Contrast utility maximization to

opportunism

5. Show connection of points on

the contract curve to points on

PPF.


Begin with a Total Product (TP) curve. With two geometric “tricks,” find Average Product

(AP) and Marginal Product (MP) curves. Discuss these concepts.

Relationship between average and marginal values.

Show TP, AP, and MP Diagram

At boundary of stages I/II, AP = MP, at boundary of stage II/III, MP = 0. Discuss

other characteristics.Why we produce in stage II of production.

Geometric Trick 1

Holding land constant and adding labor leads to a growth of TP until diminishing returns set in. APL = TP/labor. MPL = the change in TP when labor (a) increases by 1 unit. Geometrically, APL = TP/a or the slope of a ray from the origin, intersecting the TP curve at some level of output.

Geometric Trick 1

LanLandd

LaborLabor TPTP APLAPL MPLMPL

11 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

00 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9

00 2 2 5 5 9 9 12 12 14 14 15 15 15 15 14 14 12 12

00 2 2 2 1/2 2 1/2 33 3 3 2 4/5 2 4/5 2 ½ 2 ½ 2 1/72 1/7 1 1 3/43/4 1 1 1/31/3

.... 22 3 3 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2

Geometric Trick 1, the old ray from the origin trick.

Slope = rise/run = Slope = rise/run = T/aT/a

APL = TP/aAPL = TP/a Draw a ray from O Draw a ray from O

through the through the relevant point on relevant point on the TP curve.the TP curve.

Notice that this Notice that this slope rises to point slope rises to point E, then falls again E, then falls again at larger outputs.at larger outputs.


MPa = ∆TP when we use one more unit of a.MPa = ∆TP/∆Q


Find the slope of TP at a given output to determine the MPaat that output.Find the slopegeometrically by drawing a tangent line to the TP curveat the interesting output.

Draw the stages of production

Show why we operate in Stage II In stage I, we keep going for more In stage I, we keep going for more inputs because it results in growing inputs because it results in growing average and marginal productivity. average and marginal productivity. In stage III we are experiencing In stage III we are experiencing diminishing returns (negative MPa).diminishing returns (negative MPa).

Show: TVC, TFC, TC and their slopes

Total Costs

At first, TVC and TC rise gradually, Q rises faster than cost because of increasing returns.

Then, TVC and TC rise rapidly. Costs rise faster than output because of diminishing returns.


We can find the average costs from the totals, using geometric trick #1, the old ray trick.


Draw a ray from the origin through a point on the TC or TVC curve. The slope of the ray is the average cost (Rise/Run = TC/Q = AC. First it declines (increasing returns, then rises (diminishing returns).

Marginal Costs

Marginal cost is the change in TC or TVC when output is increased by one unit. Or, it is the slope of TC or TVC. Therefore, we can find it by taking the derivative of a TC function.

Marginal Costs

Or, we can use geometric trick #2, the old tangency trick. Draw a tangency to the TC (or TVC) curve. The slope of the tangent is MC.First, MC declines (increasing returns), but ultimately rises (decreasing returns).

Find SR: AVC, AFC, AC, and MC,using two geometric tricks.

Note that the APP rises and falls in correspondence with the decline,

then increase of AVC.

AP increases (AVC) falls as increasing returns to the variable factor occurs.

But as diminishing returns set in, APP falls, which means that AVC rises

Discuss LR Costs

1. No fixed factors

2. Unlimited number of conceptual

SRAC curves. Choose your output,

then the SRAC that produces it at the

lowest cost.

Discuss LR Costs

3. Envelope curve

4. “For any output, min cost by using

the scale of plant whose SRAC curve is

tangent to the LRAC curve.”

Why is it U-shaped?

Economies of scale vs. Law of diminishing returns

Economies of scale: division and specialization of labor, advanced technology, large machines, digitalization and electronics.

Diseconomies of scale: control and coordination problems

Learning curve.

Four LRAC curves

Textbook U

(Range of) constant returns

Constant returns through replication

Continually increasing returns



efficiency.

Isoquants--purpose for use

Get up to speed on diagrams.

Tight logic (and math) vs.



efficiency.

Scientists prize

-- skepticism,

-- rigorous reasoning, and

-- empirical experimentation.)

Appreciate and understand

Tradeoffs

Budget constraints

Logic of maximization

Representation of efficiency

Get ready for a quiz next session on

the production box.

1. Intuition on isoquants:

Movement NE = improvement.

Discovering substitutability of inputs.

MRTSlk = ∆ K/ ∆ L

2. Characteristics of isoquants

a. No intersection

b. Downward slope

MRTSlk = amount of K lost for which


Total Cost = C = wL + rK

Rewrite: rK = C - wL

K = C/r - (w/r)L

Intercept ratio of factor

prices (or slope of

budget line)

Slope of isoquant:

MRTSlk = MPl/MPk = ∆ K/ ∆L

Discuss diminishing MRTSlk (and tradeoffs)

∆Q = MPl(∆L) ∆Q = MPk( ∆ K)

On the isoquantMPl(∆ L) + MPk(∆K) = 0

At equilibrium

Slope of Isoquant = Slope of isocost

Mpl /MPk = w/r

Mpl/w = MPk/r

(Mpl/Pl = Mpk/Pk)

4. Show isocost line


the

Edgeworth Box:

1. Start with the two-producer barter

case of production: the Edgeworth-

Bowley Box

Gains of trade.Efficiency is being on the contract curve.

Trading from any point off the contract

curve to a point on the contract curve.

O Labor

Ca

pit

al

(Food Producer Origin)

0(Clothing Producer Origin)Labor

Ca

pital

C

O Labor

Ca

pit

al



Ca

pital

C

A

Observe a movement frompoint A to a point on theContract Curve.

B Who has gained here?Is this a net social gain?

O Labor

Ca

pit

al



Ca

pital

C

A

Observe a different movement from point A to a point on theContract Curve.

D

Who has gained here?Is this a net social gain?

O Labor

Ca

pit

al



Ca

pital

C

A

Observe a more reasonable movement from point A to point D on the Contract Curve.

D

Who has gained here?Is this a net social gain?

Movement along the contract curve

To move to the contract curve is to achieve

efficiency. What does movement along the

curve represent?

Theft, violence, opportunism–

“economic man” as rational optimizer

vs. opportunism.

The market production case.Isoquants and Isocost lines.

TC = Pl(L) + Pk(K).The easy way to draw it.

Say we have a budget of $100, Pl = $.50 and Pk = $1

$100 = .50L + K

K = 100 – 0.5L 100 is the Y intercept, K = 100 – 0.5L 100 is the Y intercept, the slope is -1 times the slope is -1 times

the ratio of the two prices (Pl/Pk).the ratio of the two prices (Pl/Pk).

Show input prices varying and resultant isocost lines.

Ownership and Property Rights.ppt,

1. Review slide (power point)

presentation for chapter 5.

2. The ppt presentation reviews

Millgrom & Roberts notes.


Ownership and Property Rights, II1. Complete property rights discussion (& “tragedy of commons”)

Coase Theorem2. Read about government actions and other solutions to externalities problem. A. Cooperation and Group OwnershipB. ReputationC. Taxes and Subsidies


2. a. Discuss overhead “The Nature of

Profits”.

b. Millgrom & Roberts on “Ownership

of Complex Assets”.


ManEc 300 Day 12Prof. Bryson The Profit Motive

Definition I. Normal Profit (as

opposed to accounting profits) assumes a return high enough to include:

A. Normal (opportunity cost) return to stockholders

ManEc 300 Day 12Prof. Bryson The Profit Motive

B. Normal (opportunity cost) return to management (and all other factors).

II. Economic Profit or “Pure” Profit is any profit in excess of normal profit.

The Function of Profit

Pure or Economic Profit permits:1. Higher than normal returns (dividends)

to owners2. Increase in value of owners’ holdings (Or, profits “plowed back” into

investments)

The Function of Profit

3. Higher than normal (opportunity cost) returns for other factors of production.

Profit can be a vitally important market signal of great social benefit.

The Origins of Profit

Profits may result from -- the exploitation of a

monopoly position, -- from innovative

entrepreneurship and the effective introduction of new technologies (cost-cutting or revenue generating) in the face of risk, or

The Origins of Profit

Profits may result from --from a new and

superior means of satisfying consumer demands

Profit Maximization and Other Theories

1. Profit maximization, say most economists, is the best general theory. It has to work in pure competition.

2. Where a firm has little competition, or competitive “slack”, it may be at liberty to pursue other objectives, while “satisficing” profits.

Profit Maximization and Other Theories

Other objectives might include: A. Maximizing Sales Revenues B. Maximizing Market Share C. Ensuring Long-term Survival D. Pursuing growth and

Diversification for the firm E. Pursuing Social Objectives

The Simple Mathematics of Micro

Production theory. Begin with a production function:

showing output, Q, a function of the variable input, labor, a.

Marginal product of labor (MPa) isa) the addition to total product resulting from the use of one more unit of a.

The Simple Mathematics of Micro

Marginal product of labor (MPa) isb) the slope of the total product curve, andc) the first derivative of a total product, TP, function, thus,

dQ/da = MPa = 21 + 18a - 3a2*_______________________

Taking Derivatives

*You will remember about first derivatives that:

to get the derivative of a constant, dQ/da = 0. For example, in the expression

Q = 21 + 7a - a2 + 3a3, the number 21 is a constant, for which

dQ/da = 0.

Taking Derivatives

To get the derivative of a variable “a” preceded by a coefficient m, or ma, dQ/da = m.

For example, in the expression Q = 21 + 7a - a2 + 3a3,

the term 7a consists of the coefficient 7 and the variable a, for which dQ/da = 7.

Taking Derivatives

To get the derivative of a variable with an exponent, an, dQ/da = nan-1.

For example, in the expression

Q = 21 + 7a - a2 + 3a3,

the term a2 consists of the variable a and the exponent 2, for which dQ/da = 2a.

Taking Derivatives

(By the formula, this would read 2a1, but any number or variable taken to the first power, i.e., having an exponent of 1, is not changed. So we need not write the 1.)

Taking Derivatives To get the derivative of a variable with

both coefficient m and exponent n, such as man, we have dQ/da = n(m)an-1

For example, in the expression Q = 21 + 7a - a2 + 3a3, the term 3a3 consists of the variable a

with the coefficient 3 and exponent 3, for which

dQ/da = 9a2.

Taking DerivativesFor the entire expression, Q = 21 + 7a - a2 + 3a3, we get the derivative

dQ/da = 7 - 2a + 9a2.For average product, AP, we have

APa = (TP/a) = (21a + 9a2 - a3)/a = 21 + 9a - a2

Cost Analysis Now consider costs, using the same

kind of analysis. We recall the simple short-run relationships, specifically that total cost, TC, equals total fixed costs (TFC) plus total variable costs (TVC) or

TC = TFC + TVC

Cost Analysis

TC = TFC + TVC

Dividing both sides by Q, or quantity of output, we have

TC/Q = TFC/Q + TVC/Q, or AC = AFC + AVC.

Cost Analysis

For total cost, consider the expressionTC = 128 + 69Q - 14Q2 + Q3.

Here, TFC = 128 and TVC = 69Q - 14Q2 + Q3.

Cost Analysis

MC = dTC/dQ = dTVC/dQ = 69 - 28Q + 3Q2

AVC = TVC/Q = (69Q - 14Q2 + Q3)/Q = 69 - 14Q + Q2

The Demand Function

Consider now a demand function such as

P = 3200 - 13Q.

It will be recalled that demand = average revenue, AR, so we also have

AR = 3200 - 13Q

The Demand Function

Note that in this expression of a linear demand function, 3200 is the intercept, -13 the slope.

To get total revenue, TR, we observe that TR = P x Q, so

TR = 3200Q - 13Q2

Marginal Revenue

Marginal revenue, MR, is simply the slope of a total revenue curve, or the first derivative of a TR function,

so from P = 3200-13Q. TR = PQ = 3200Q – 13Q2

MR = dTR/dQ = 3200 - 26Q.

Marginal Revenue

It will be noticed that the MR has the same intercept (3200) as the demand or average revenue curve, while the slope(-26 rather than -13) of MR is twice as great as the slope of AR, i.e., the MR curve falls twice as fast as the demand curve.

Maximizing Profits

Now, maximizing the firm’s profits.TR = PQ = 3200Q - 13Q2

MR = 3200 - 26Q.Assume: TC= 24,000 + 500Q - 13Q2 + Q3,

MC = 500 - 26Q + 3Q2.

Maximizing Profits

To get profit maximization, we simply equate MC and MR, so MC = MR

3200 - 26Q = 500 - 26Q + 3Q2

2700 = 3Q2

900 = Q2

Q = 30

Optimal Price with Quantity = 30

Looking back at the demand function again, we have

P = 3200 - 13(30)P = 3200 - 390P = 2810.

This is the right price to charge for sales of 30 units of output in the pursuit of maximal profit.

Don’t forget the group math homework

due next session.

1. Math assignment Hints:

Problem 3: plug value of Q into formula

up front, not after you have

differentiated.

FOR THE NEXT SESSION

Note that dp/dq = 1/(dQ/dP),

dQ/dP = 1/(dP/dQ)

No quadratic equation used.

Follow problem 4's hint. Factor Q2 so

(...Q)(...Q)

FOR THE NEXT SESSION

As soon as the next discussion (on

competition) Is complete, we will have

a quiz on that topic.

Please look at the reading for the next

session..

ManEc 300 Conclusion, Day 12 Prof Bryson

Pure Competition The assumptions of pure competition.

– A large number of buyers and sellers– Product homogeneity– Free entry and exit

The assumption that makes for perfect competition– Rapid dissemination of low-cost, accurate

information

Pure Competition

Discuss the standard, market/firm, double diagram of competition.

Short-term profits lead to entry, which can impact costs: constant, increasing, decreasing.

3. Review of pure competition.a. TC, TR and NR diagrams for NR>0, NR=0, NR<0.b. When making losses? When shut down? (Go fishing)

ManEc 300 Day 13 Prof. Bryson Pure Competition

3. Review of pure competition.c. Why is perfect competition efficient?d. Show constant & increasing (then

decreasing) costs.4. Why all cost curves are equal in

competition

e.

ManEc 300 Day 13 Prof. Bryson Pure Competition

As soon as the next discussion (on competition) Is complete, we will have a quiz on that topic.

Please look at the reading for the next session..

The assumptions of pure competition. The assumptions of pure competition. A large number of buyers and sellersA large number of buyers and sellers Product homogeneityProduct homogeneity Free entry and exitFree entry and exit

The assumption that makes for The assumption that makes for perfect competitionperfect competition Rapid dissemination of low-cost, Rapid dissemination of low-cost,

accurate informationaccurate information

Discuss the standard, market/firm, Discuss the standard, market/firm, double diagram of competition.double diagram of competition.

P

Q qqq

Short-term profits lead to entry.Short-term profits lead to entry.

P=MR=AR

D

S

0 Q

P

q

PS’

Entry can impact costs: constant, Entry can impact costs: constant, increasing, decreasing.increasing, decreasing.

First, consider an increasing cost First, consider an increasing cost industry in pure competitionindustry in pure competition

1.1. Demand IncreasesDemand Increases2.2. Price risesPrice rises3.3. Entry Occurs, pushing S out to the Entry Occurs, pushing S out to the

rightright4.4. Costs change as a result of entry, here Costs change as a result of entry, here

they risethey rise

P=MR=AR

D

S

0

P

q

Consider now a decreasing-cost Consider now a decreasing-cost industry in pure competitionindustry in pure competition


rightright4.4. Costs change as a result of entry, here Costs change as a result of entry, here

they fallthey fall

P=MR=AR

D

S

0

P

q

Finally, consider a constant-cost industryFinally, consider a constant-cost industry


rightright4.4. Costs usually change as a result of Costs usually change as a result of

entry, but here they remain the sameentry, but here they remain the same

P=MR=AR

D

S

0

P

q

TC, TR and NR diagrams for NR>0, NR=0, NR<0.

TR

TC

NR

TC

NR

TC

NR

When making losses? When shut down? (Go fishing)

NR

TC

TR

If we shut down, wemust pay?

Total Fishing Costs!

TFCIf we produce, we suffer only our operatinglosses

Why is perfect competition efficient?

The consumer pays only the minimalaverage costs of production.All factors of production get normal opportunity cost returns.

Why all cost curves are equal in competition

Firm A Firm B

Assume Firm A has a production factor thatreduces production costs, lowering cost curves

Firm B and many others will try to bid that factor away from A. If A doesn’t pay that factor more,It will leave. So A’s cost curves go back up.

Quiz on competition

Begin monopoly

See Power Point presentation

Day 15Review session before midterm.Day 16 Midterm at Testing Center.


1. PowerPoint presentation of

monopoly.

2. There will be a multiple choice quiz

next class session on monopoly.


Discussion on monopoly regulation and contestable markets.

ManEc 300 Days 18, 19Prof. Bryson

Announcements:In the File Directory, see “Practice Multiple Choice Questions.doc.” At the bottom of the file are references to on-line multiple choice questions for practice and tips on doing them.


Competition from a spiritual perspective. . Discussion on Price discrimination Monopolistic competition


Begin oligopoly, which will cover The Kinked Demand Curve (see ppt) Baumol’s model of Sales Maximization with a profit constraint, and Game theory

Profit constrained sales maximization

Goal: maximize total revenue (dollar sales, not physical volume), while making sufficient profit.

Sufficient profit– Pays satisfactory dividends– Provides net investment for growth– Ensures financial safety, and– Retains capital market confidence.

Baumol on Sales Maximization Oligopoly and the real world

X

$

0

TR

TC

Min ΠNR

A

We used this model for Monopoly, and it applies here.

A = NR or Π maxC = Sales max, butwith big losses.

B = greatest sales that still yield sufficient and minimally requiredprofit.

B C

Baumol: conclusions

This is not really like cost-plus pricing, which produces some output, figures the cost and adds a profit markup. Baumol’s model pre-determines output B as the greatest one that yields sufficient profit.

Baumol: conclusions

This model incorporates interdependence, which can shift around the TR curve greatly.

Lack of emphasis on profit here may help avoid anti-trust action and entry.

2. Kinked Demand Curve

PowerPoint presentation


ManEc 300 Session 22Bryson

Conclusion of Oligopoly. Power Point Presentation on Game Theory

BOUNDED RATIONALITY AND CONTRACTING


The motivation problem. The question here is

motivation. Management must assure that the various actors and contract participants actually do their parts, both acting and reporting appropriately.

BOUNDED RATIONALITY AND CONTRACTING


Incentive Compatibility People will do only what they

perceive to be in their interests. Affairs need to be arranged so that while pursuing their own interests, peoples’ actions also promote the interests of the corporation and (from the standpoint of the economist) the interests of the society as well.

BOUNDED RATIONALITY Perfect, complete contracts. Contracts (or at least voluntary agreements)

are the means by which mutual interests are pursued.

The motivation problem: all relevant plans cannot be completely described in enforceable contracts. To write a perfect contract, parties would have to foresee all contingencies, then agree on an efficient course of action responding to each one.

BOUNDED RATIONALITY Perfect, complete contracts. But we must contract with bounded

rationality, i.e.,– limited foresight, – imprecise language,

In the face of bounded rationality, people act in an intentionally rational manner, doing the best they can given these limitations.

Contingency Responses

Especially when unforeseen contingencies

arise, parties often adapt opportunistically. Incomplete and unenforceable contracts lead

to problems of imperfect commitment.


Where contingencies are foreseen, impacts and probability of occurrence may be misperceived, so they may not be included in the contract.

Contracts usually relatively inflexible, covering many provisions very broadly.


Relational contracting avoids comprehensive contracts– agreement about goals and objectives – general provisions broadly applicable. – Procedures are outlined for making

decisions and mechanisms for appeal.

Private Information and Adverse Selection

In contracting, private information may prohibit a value-maximizing agreement.

If private information held by one party we can incur an adverse selection problem.

Private Information and Adverse Selection

The most famous example of asymmetric information and adverse selection:if the seller of a used car knows it is a lemon, the selection of products (cars) offered in a market is determined in a manner adverse to the buyers’ interests.

Pre-contractual Opportunism

Adverse Selection

Used Cars Insurance

(Maternity) Gifthorse, or

gifthamster

Auto air-conditioner– (Nissan/Calsonic-

Harrison Co.

A JV no. of Tokyo)

Cases of Asymmetric Information

Courtship

Market vs. Government Solutions

Where AS is strong enough, the price of insurance can be driven so high that nobody can afford it, so that market collapses. No insurer, facing costs of insurance payments, plus overhead, can afford to serve the set of customers who wish to buy insurance.

Market vs. Government Solutions

George Akerloff (“lemon markets”) showed that the volume of trade in markets with AS is inefficiently low. As we have seen, the market can also fail. That failure often leads to clever alternative arrangements and practices in the private sector. Too often, some advocate that the government jump in with subsidies before seeing what the private market will come up with.

Adverse Selection in Bank Loans

AS in Bank Loans. The interest rates that a bank charges can affect the selection of customers who apply for loans: when there is excess demand for loans, a bank may be inclined to raise its interest rates.

Adverse Selection in Bank Loans

But at high rates, only those customers with very risky investments may be seeking loans. The bank should ration credit in cases of excess demand, rather than raising the interest rate.

Signaling and Screening

Signaling is an attempt to communicate private information credibly.

Example:– Talented workers may gain additional

education as much for the value of credentials as to enhance their actual productivity.


Screening is done to attract only desirable potential customers, workers, etc. Or, at least to sort groups into quality categories.


Example:– offering some jobs with incentive pay

schemes and others with fixed wages may tend to sort the workers. The most productive ones will tend to select the incentive pay jobs.

Alert!

For tomorrow, go through the scheduled

Power Point on Moral Hazard. We will

have a quiz on it.


ContractIncomplete,

Bounded Rationality

Imperfect Commitment

Reneging

Holdup Problem

specific assets

co-specialized assets


Commitment and Reneging

One of the parties to an imperfect contract may try to renege -- payment won’t be made or the product won’t be delivered.

Commitment and Reneging

Contract ambiguity may make it difficult even to know who is reneging.

Fear of reneging may cause a contract not to be completed in the first place.

Contract Renegotiation

A second commitment problem is that sometimes it becomes necessary to engage in ex post renegotiation of the contract.


Example:– Some firms provide incentives to

executives by issuing stock options stating they can purchase stock at a specific price on future dates. The managers are supposed to work to get the stock price higher giving them a windfall gain.


Example:– But if after the options are issued a

firm’s stock price falls drastically, the options are worthless and won’t provide incentives. So it will pay to renegotiate.

The Hold-up Problem

Where both parties to a contract need to worry about being forced to accept disadvantageous terms later, after it has sunk resources into an investment, there is a hold-up problem.

The Hold-up Problem

The problem: specific use of particular assets in imperfect contracting.

Fearing that a big investment may lead to later vulnerability can lead to a refusal to make the efficient investment.

The Hold-up Problem: Example

If a coal mine supplies a local power plant (as its only customer) and a big investment is required, will the relationship continue after the expensive investment? What will the price of coal be in the future?

The Hold-up Problem: Example Post-contractual

opportunism may result, so parties can exploit loopholes to gain unfair advantage. A common response to a cospecialized assets problem is for the same party or firm ultimately to own both assets.

Is this acceptable business behavior?

Is this fair behavior?

Is this OK behavior?

Is this behavior we all engage in?

Is this moral behavior?

Read George Q. Cannon Statement

We should critically evaluate opportunistic behavior

George Q. Cannon on Informational Asymmetry

Collected Discourses, Vol.5, George Q. Cannon, October 6, 1895I might go on and speak about stealing, and dishonesty, and many other sins. I believe that the Latter-day Satins as a people are a more honest people, that they respect their obligations more than other people.


Collected Discourses, Vol.5, George Q. Cannon, October 6, 1895

We show this in our business associations and dealing. We have the credit for it everywhere. Men who have found fault with our religion frequently acknowledge that we are an honest people, and our credit is "gilt edged." But there are some things that we are still guilty of.


I believe, however, that the young and rising generation will outgrow them. It is a strong temptation for a man, when he has got a piece of property and he has a chance to trade or sell it, to let the buyer think it is better than it is.


Now, if we were strictly honest, we would tell exactly the character of that which we have to sell. We would not allow a man to deceive himself; we would tell him the facts. But I know that we are all under the influence of the old traditions.


The old traditions were that a man should have his own eyesight, and that the seller should not furnish him with anything to aid his perception or to enable him to perceive something that he would not otherwise see. It is a hard thing for men who have grown up under that system of things to refrain from it.


You see everywhere where things are for sale the endeavor to make them appear better in the eyes of the purchaser than they are. We have got to change in this respect. Whenever a man yields to do a dishonest thing he yields to Satan, and Satan has influence and power over him to that extent. We have got to learn to overcome these things, and to have Satan bound.

Suggestion: Begin Reviewing for Final

In just a few days we will have an in-class review for the final. Please bring your questions to that session for discussion.

Tomorrow there will be a quiz on moral hazard.

Post-contractual Opportunism:Moral Hazard, Session 24

The definition: MH is the form of post-contractual opportunism that arises because actions that have efficiency consequences are not freely observable and so the person taking them may choose to pursue his or her private interests at others’ expense.

Post-contractual Opportunism:Moral Hazard, Session 24

The term originated in the insurance industry, where the tendency of people was observed to change their behavior in a way that led to larger claims against the insurance company (e.g., being lax about taking precautions to avoid or minimize losses).

Commitment vs. Monitoring

Shirking, Fraud/Deceit .

In the case of the residual claimant, who

monitors the monitor?

South African Hosp

AMA, Doctors vs. Litigation

ManEc 300 Day 24 Bryson

Principle-agent relationshipCase of US Savings & Loan CrisisS&L’s borrow from savers, loan for

mortgages-- low interest ratesFSLIC Insurance1980’s Fed Interest Rates

Deregulation (cease monitoring)


S&LS CONTINUED:

Fraud (25% of S&L bankruptcies)

Depositors didn’t monitor (insured)

Politicians wouldn’t monitor


Note public insurance examples:

• Gov. Nat’l Mortgage Association

(GNMA)-- insurance against default

• Student Loans


Economic Strategy and Michael Porter

See and discuss Power Point, “Bryson on

Porter”

The firm’s competitive advantage

2.The Gershwin-playing hamster


ManEc 300 Days 26, 27Bryson

Discussion of Organizational Architecture.ppt Review for final.

A little final math practiceSuppose a firm’s TR is given as TR = 500Q - 4Q2Suppose a firm’s TR is given as TR = 500Q - 4Q2 When output is 100, TR isWhen output is 100, TR is

a. $2,000.a. $2,000.b. $20,000.b. $20,000. c. $10,000.c. $10,000.

d. $49,600.d. $49,600. e. None of the above.e. None of the above.

Suppose a firm’s TR is given as TR = 500Q - 4Q2Suppose a firm’s TR is given as TR = 500Q - 4Q2 When output is 10 units, AR isWhen output is 10 units, AR is

a. $460.a. $460. b. $560b. $560 c. More than c. More than $500$500

d. $360d. $360 e. None of the above e. None of the above

When TR = 500Q - 4Q2When TR = 500Q - 4Q2

At an output level equal to 20, MR isAt an output level equal to 20, MR is

a. $440.a. $440. b. $340b. $340 c. More than c. More than 500.500.

d. None of the above.d. None of the above.

Marginal revenueMarginal revenue

a. always exceeds marginal cost.a. always exceeds marginal cost.

b. always equals marginal cost.b. always equals marginal cost.

c. is the tangent of the average revenue c. is the tangent of the average revenue curve. curve.

d. is the slope of the total revenue d. is the slope of the total revenue curve.curve.

e. is the distance between total revenue e. is the distance between total revenue and total cost curves at optimal output.and total cost curves at optimal output.

When TR = 500Q - 4Q2When TR = 500Q - 4Q2

Marginal revenue and average revenue Marginal revenue and average revenue are equal whenare equal when

a. Q = 10.a. Q = 10. b. Q = 0.b. Q = 0. c. Q > 0.c. Q > 0.

d. Q < 0.d. Q < 0.e. None of the above.e. None of the above.

ManEc 300Day 1 Bryson 1. This daily outline is subject to revision and upgrading. It might be wise...

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