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14.01:FinalReviewDecember3,2010

Unit 5: Market Power

1 Lecture17: OligopolyContinued(Chapter12)I. CournotMath

Cournot: Allfirmssetquantitiesatthesametime Calculateresidualdemand foragivenfirmandsolve itsprofitmaximizationproblemtofind its

bestresponsefunctiontootherfirmsoutputdecisions. Solution isasetofquantities(oneforeachfirm)thatsolvesthissystemofequations.

II. CooperativeEquilibrium- Cartels Firmscanformacartelandbehave likeasinglemonopolist,maximizingtotalindustryprofits. Cartelsareunusualbecausetheyarefundamentallyunstable(incentivetocheatandraiseown

production)andbecausetheyareillegal(antitrustlaws).III. ComparingEquilibria

Intermsofwelfare,usuallyPerfectCompetition>Oligopoly>Monopoly Quantityasanindicatorofsocialwelfare DWLinwelfareanalysiscomesfromtradesthatarentmade

IV. ManyFirms InCournot,asnumberoffirms,Cournotequilibriumapproachescompetitiveequilibrium Asnumberoffirms1,approachesmonopoly Markupovercompetitivepricedependsonnumberoffirmsandelasticityofdemand:

pMC 1p =n

V. PriceCompetition Bertrand: firmssetprices(insteadofquantities)atthesametime Twofirmsmaybeenoughtoremovemarketpower(i.e. restorecompetitiveoutcome)ifproducts

are identical RecallprooffromclassthatidenticalBertrandduopolistsdrivepricedowntomarginalcost AlsorecalltheStackelbergmodelwhereonefirmsettheirquantitybeforetheotherfirm. Inthis

case, the best response function for the Stackelberg leader takes into account the fact that thefollowerwillrespondtotheleadersoutputdecision.

Unit 6: Topics in Intermediate Microeconomics

2 Lecture18: FactorMarkets(Chapter15)I. CompetitiveFactorMarkets

InSRandinLR,demandforlaborwillbe itsmarginalrevenueproductMRPL =MR MPL

where MR is marginal revenue from additional unit of output (MR =p if competitive outputmarket). These will differ in LR and in SR becauseMPL in LR will take into account optimalcapitaladjustments.

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LR labordemandmoreelasticthanSRII. Monopsony

Monopsony: singlebuyerin inputmarket Barrierstoexit(fromfactormarket)createmonopsony Competitivefirmsconsiderpriceof inputs,butmonopsonist looksatmarginalexpenditure.

ME(q) =dTE(q) =d[p(q)q]dq dq

Takespoisoningeffecton inframarginaluntis intoaccount IncreaseinputusageifMEMRP. Pricecomesfromsupplyfunction Monopsonistsunderhireat lowerwagesrelativetoperfectcompetition

III. Application: MinimumWage Higherminimumwagescanrestorecompetitiveoutcomeinamonopsonisticmarket

3 Lecture19: InternationalTradeI. What isInternationalTrade?

tradedeficit= imports-exportsII. ComparativeAdvantageandGainsfromTrade

Differences inopportunitycosts leadtocomparativeadvantage indifferentgoods Whencountrieshavedifferentcomparativeadvantagesinproductionofdifferentgoods,thereare

potentialgainsfromtradethroughspecializationIII. WelfareImplicationsfromInternationalTrade

Incompetitivemodel,openingtotradeincreasestotalwelfarebutusuallyattheexpenseofeitherconsumersorproducers

PracticewelfarecomparisonsusingtheusualgraphsforimportsandexportsIV. TradePolicy

Effectsoftariffsandquotas4 Lecture20: Uncertainty(Chapter17,sections1-3)

I. Decision-MakingUnderUncertainty Expectedutility: probability-weightedaverageofutility

EU =Pr(Lose) U(Lose)+Pr(Win) U(Win) Differentthanutilityofexpectedvalue,sinceutility functionsusuallyconcave(diminishingMU

of income)II. Extensions

Concaveutility(decreasingMU income)riskaverse2

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Linearutility(constantMU income)riskneutral Convexutility(increasingMUincomeriskloving

III. Applications Insurance: riskaversepeoplewillpaymoneytoturnagambleintoacertainpayoffsincetheyget

higherutilityfromcertainincomethanfromagamblewiththesameexpectedvalue Maximumamounttheyrewillingtopayforthis istheirriskpremium Lotterybehavior isapuzzlemayberiskaverseatlow incomesandrisk lovingathigh incomes

Lectures21and22:CapitalSupplyandCapitalMarkets(Chapter16)Lecture 21 - Capital Markets

I. CapitalandIntertemporalChoice Supply of capital from household decisions about how much to save increasing in interest

rate Demandforcapitalcomesfromfirmswithpotentiallyproductiveinvestmentstomake Intertemporal choice graph over consumption in period one (C1 on x-axis) and in period 2

(C2 ony-axis). SlopeoftheBC is(1+r) Whenrchanges,effectonsavingsdependsonrelativesizeofIEandSE

II. PresentValue Needtotranslateallfuturedollars intotodaysterms ForasinglepaymentofFV inyeart:

FVPV =

(1+r)t Valueofaperpetuityconstantpaymentoff everyperiodforever:

PV =f/r Importanceofcompunding

Real interestrater istheonewecareaboutthenominalinterestrateiminus inflationr=i

Lecture 22 - Capital Markets III. ChoicesOverTime

ChooseoptionwithhighestpresentvaluewhenchoosingbetweenprojectsorinvestmentsII. InvestmentDecisions

NetPresentValue(NPV)=PVofrevenues- PVofcosts

Rule:

Investif

NPV

greater

than

zero

ifrevenuesRt ineachperiodandcostsCt,NPVofinvestment is:

NPV = (R0C0) +R1C1 +R2C2 +. . .+RtCt(1+i)1 (1+i)2 (1+i)t

NPVdecreasing ininterestrateforprojectswithup-frontcostsandfuturepayoffsIII. IncreasingSavings

Savingsimportantforeconomicgrowth Governmentencouragessavingsusingtaxsubsidiestoretirementsavings

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SWF =f(U1, U2, . . .)UtilitarianSWF

SWF =U1 +U2 +. . .RawlsianSWF

SWF =min(U1, U2, . . .)III. InequalityintheUSandAroundtheWorld

Seeclasshandoutsoninequality,poverty line,povertyratesovertimeIV. SourcesofLeakage

Recall transfer program discussed in class leads to decrease in labor supply especially amongthosewhoqualifyorareoriginallynearthecutofftoreceivethesubsidy.

DistortionarytaxationleadstoDWLthisisthecostofredistribution7 Lecture24: TaxationandRedistribution

I. Taxation intheU.S.1. Incometax(progressive,maintaxintheU.S.)2. Payrolltax(flat)3. Consumptiontax(regressive,paidonspendingratherthanearnings)4. Propertytax(taxonwealth)5. Corporatetax(taxonbusinesses,smallshareoftotaltaxrevenue)

II. WhatShouldWeTax? EuropeancountriesraisemostrevenuethroughVATonconsumption Consumptiontaxesencouragesavingsbutnotprogressive Excisetaxesusuallyonsingoods(goodswithnegativeexternalitiesinconsumption)

III. What istheRightTaxRate?Taxrevenues=base t

Astaxraterises,baseshrinksd(taxrevenue) d(base)

=base+tdt dt

Laffercurvetaxrevenueinitiallyrising,thenfallingwithtaxrate(dependsonelasticityoftaxbase)

IV. LowIncomePrograms intheU.S. Importanceoftargetingassistanceprograms Earned Income Tax Credit (EITC) is a wage subsidy program that balances targeting and effi

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Unit 7: Equity and Efficiency

6 Lecture23: EquityandEfficiency(Chapter10)I. EquityandEfficiency

II. ChoosingtheSociallyOptimalAllocation Socialwelfarefunction(SWF)canbethoughofasautilityfunctionforsocietytakingindividual

utilitiesas inputs

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