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262 Cards in this Set

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Utility
The satisfaction derived from consuming a good or service
Util
An introspective unit of satisfaction; i.e., a quantitative measure of utility that considers one's own feelings.
Supply is a function of...
cost
Demand is a function of...
utility
Price is...
an equilibrium of quantity supplied (QsubS) and quantity demanded (QsubD), therefore the equilibrium price is the one price that sets QsubS = QsubD and clears the market at the equilibrium quantity QsubE
What are the two methods of measuring utility?
Cardinal Numbers
&
Ordinal Numbers
Cardinal Numbers
Numbers that assign specific value, e.g., 1, 2, 10

From Menger
Ordinal Numbers
Numbers that assign rank, e.g., first, second, tenth

From Edgeworth
D =
D = f(U) (U = utility)

Defined: both the ability and willingness to enter the market at some specific price
S =
S = f(c) (c = cost)
Mill => TU
The total satisfaction provided at different levels of consumption
Walras => MU
The delta in TU caused by the consumption of one additional unit
Total Utility
The total satisfaction provided at different levels of consumption (Mill)

Primer Def: (TU) The total satisfaction derived from all units consumed (see marginal utility)
Marginal Utility
The change in total utility caused by the consumption of one additional unit, the slop of TU (Walras)
Satiation
The point on the total utility function where satisfaction is maximized, i.e., where marginal utility equals zero (Maximum total utility).
MU/P Ratio
Marginal Utility per dollar spent
MU/P ratio standard
The unique MU/P ratio that an individual consumer requires with each purchase
P in the MU/P ratio
The number of hours you have to work to buy the good (not the dollar value)
If you change the price do you change the MU/P?
yes
Does changing the price in MU/P change DEMAND?
No, the demand was always there, this just made it observable in the real world.
Law of Demand
The quantity demanded increases as the price decreases (Marshall)
Consumer Surplus
Utility received but not paid for

NOTE: ~ 40% of the world's consumer surplus is captured by Americans
The Law of Diminishing Marginal Utility
The amount of satisfaction received per unit of consumption decreases as the quantity consumed increases

NOTE: The slope of the MU function is always neg
Indifference Curves
A function that shows how much of one good it takes to make someone ambivalent to a given amount of some other good (Edgeworth)
Indifference Curve Assumptions
1. Isoquant
2. Convexity
3. Asymptote
4. Rationality
5. Transitivity

NOTE: There are uncommon exceptions.
Isoquant
Line of equal satisfaction.
iso = equal so anywhere you are on the function, whatever you are measuring is exactly the same
Convexity
Law of substitution
Law of diminishing marginal utility
Asymptote
Two lines approaching but never intersecting
Rationality
More is preferred to less
Transitivity
Mathmatically logical
A>B and B>C then A>C
Causes the indifference curve never to cross (most of the time)
Exceptions to Convexity on Indifference Curves
a. Perfect substitutes (linear)
-Ex. Hard/soft coal - and are mutually exclusive - ONLY WANT MOST HEAR PER DOLLAR SPENT
b. Perfect compliments (right angle)
-Ex. Wheels and chassis - MUTUALLY DEPENDENT
c. Resistance/addiction (concave)
-Ex. Heroin v. all other goods (AOG); ADDICTION (use requires use) & DEPENDENCE
d. Tolerance and dependency offset by rational behavior (wavy line)
-Ex. Education or Collections v. AOG;
Budget Constraints
The line of all possible combinations of goods that can be obtained with a given budget
Equilibrium on a Budget Constraint
the point where the budget constraint is tangent to the indifference curve of highest utility
Changes in Budget Constraints
a. Shift - change in money income (Paycheck)
*Due to change in MONEY INCOME (Paycheck)
b. Pivot - change in real income (Buying power)
*Due to a change in REAL INCOME (buying power)
Is the demand curve linear or curvelinear?
Curvelinear, but we can assume it is linear for small parts of a large range
Demand
Both the ability and willingness to enter the market at some SPECIFIC price, this is a necessary condition
Effective Demand
Both the ability and willingness to pay the current market price, this is a SUFFICIENT condition (current market price is the equilibrium price)
Demand Shift
Change in price does not change demand, it changes the location of the demand curve which makes the demand curve observable in the real world, the demand was always there.
Causes for Changes in Demand
* In general, need to convince people that they will get more UTILITY

a. Changes in Income
b. Change in taste
c. Change in price of other goods
d. Advertising (Madison Ave.)
Causes for a change in the quantity demanded
Changes in the price of a good in question
Law of Downward Sloping Demand
The quantity demanded increases as the price decreases. This describes a normal good. (Marshall's Law)
Normal Good
A good or service which has two characteristics both of which are NECESSARY conditions.
1. Substitution Effect
2. Income Effect

When a good disobeys the law of demand it is because one of these two (but not both)of these conditions has been reversed (abnormal good)
Substitution Effect
When the price of a good is decreased and it thereby becomes an attractive alternative to another good previously purchased, and, as a result, the quantity demanded is increased.

*Causes the consumer to shift away from a good that is becoming comparatively more expensive.

*Changes the slope of the BUDGET CONSTRAINT, but leaves the consumer on the SAME INDIFFERENCE CURVE.
Income Effect
When the price of a good is decreased (pivot) and it thereby increases real income, and, as a result the quantity demanded is increased (superior good)

*If the price of the good decreases, you buy a superior Quantity of the good
Superior Good
A good that is bought in larger quantities as real income increases, or vice versa, i.e., a normal income effect
Inferior Good
A good that is bought in smaller quantities as real income increases or vice versa (Geffen good - Irish potato famine), i.e., reverse income effect
All normal goods...
All normal goods are superior, but not all superior goods are necessarily normal
Reverse Income Effect
When the price of a good is decreased and it thereby increases real income and as a resule, the quantity demanded is decreased (only exists when demand is relatively inelastic) (Inferior good)
Conspicuous Consumption
Some goods are preferred to others because of their social implications, i.e., that prestige is afforded as a function of price

From Thornstein Veblen's Theory of the Leisure Class
Conspicuous Consumption: Reverse Substitution Effect
When the price of a good is increased and it thereby becomes an attractive alternative to another good previously purchased (only exists when demand is relatively elastic).
Conspicuous Consumption: Increase in price...
Increase in price increases MU (i.e., Scotch and hight prices - people bought more)
Luxury Good
A good for which the elasticity is greater than 1
Necessity Good
A good for which the elasticity is less than 1
Elasticity
Def: Responsiveness of a dependent variable to a change in an independent variable
*Responsiveness of the quantity supplied and the quantity demanded to a price change
e =
e = (%deltaQ)/(%deltaP)
= (Q0-Q1/(Q0+Q1)/2)/(P0-P1/(P0+P1)/2)
= (deltaQ/Q)/(deltaP/P)
= PdeltaQ/QdeltaP
|e| = infinity
Totally elastic
|e| > 1
Relatively elastic (a luxury)
|e| = 1
Unit elastic
|e| < 1
Relatively inelastic (a necessity)
|e| = 0
Totally inelastic
Elasticity is determined by?
The amount of time available.
*When price changes, individual makes adjustments.
*More time = More Flexability and S & D curves become more elastic (greater the change in Q)
*Buyer Ex.: Find substitute
*Seller Ex.: Increase capital equipment to lower costs.
What is elasticity about?
a. Demand
b. Supply
c. Quantity
Quantity
What is Revenue all about?
Customers behavior, or DEMAND.

It is NOT ABOUT profit.
Where is profit maximized?
Where MC = MR
(or slope TC = slope TR)
What is Average Revenue?
Verbal and Math
The demand function or consumer price line

AR = TR/Q = (P*Q)/Q = P
Maximizing Revenues is?
REDICULOUS, what you want to maximize is PROFITS
Total revenue is maximized when?
TR = max when demand is unit elastic
Marginal Revenue
The change in total revenue caused by the sale of one additional unit.

TR max => MR = 0
Memorize Note O and Note P in Primer.
Note O: Elasticity - pp 33

Note P: Revenue - pp 37
D = f(?)
Q = f(U)

Demand is a consiquence, or function (f) of, utility (U)
S = f(?)
S = f(C)

Supply is a function of cost(C)
Q = f(?)
Q = f(P)
What is MR when Demand is linear, downward slopping, and extends to both axis?
MR is:
1. Linear
2. Begin at the D curve-Price-Axis intercept
3. Will cross at the mid-point between the origin and teh demand curve quantity axis intercept
Find MR with neg slopped, linear demand that extends to both axis.
MR begins at P, is linear, downward slopping, and crosses the X-axis at 1/2Q.
Find MR when there is Perfect Competition.
MR = AR = MR = P
What does Perfect Competition look link on a Demand Curve?

Express the elasticity?

What does this suggest?
Linear and horizontal.

This means demand is totally elastic.

This suggests the availability of close substitutes.

TR would be the same regardless of quantity sold because no increase in price is needed to increase sales(MR=D=AR=P)
TC =
VC + FC
Fixed Costs
&
Examples
(FC) A cost that is incurred regardless of the level of production; i.e., the quantity supplied remains the same regardless of price. (see price taker)

*AKA - Sunk Cost

Examples: rent, utility bills, insurance
Variable Costs
&
Examples
(VC) A cost that is zero at zero production and increases as production increases.

Examples: labor, raw materials
AFC
Average Fixed Costs

AFC = FC/q

Total cost per unit goes down as more units are produced. Takes advantage of Division of Labor.
AVC
Average Variable Costs

VC/q
Inflection point on VC or TC graph.
Point of Diminishing Returns
Y axis is cost
X axis is q

On q axis:
< is area of decreasing MC
> is area of increasing MC
Normal Profit
The amount of accounting profit required to maintain a business without attracting competitiors

Lies somewhere in the TC function

See this as a cost of doing business
Can "Normal Profit" be a negative accounting profit?
Yes.
Examples: sports team, retired person opens knick-knack shop to keep busy
Marginal Costs
The change in total costs caused by the production of one additional unit.
Capacity Point
Minimum Average Cost
Minimum Average Cost
*The optimal level of production where output cannot be increased without increasing the averave cost per unit. (capacity point)

*The Min AC is the same as maximizing Pareto's Production Possibilities Curve.
Minimum Marginal Cost
Is where the inventors live. The best product and the best space for their employees. But competitors will not work like this.
Capacity point: maximize or optimize?
Optimizing, because you can produce more, it is just not the most cost effective mix.

Ex. In 1944, US was at 144% capacity for steel.
Where is the point of Diminishing Returns on a MC function?

On a TC or VC function?
On an MC function, it is the minimum point.

On a TC or VC function, it is the inflection point.

This is the benchmark beyond which a business must go to maximize profits.
Average Costs
FC/q

The function is an asymptote found by dividing fixed costs by the number of units produced.
ATC (or AC) =
ATC = AVC + AFC
1. MC > AC

2. MC < AC
1. AC will increase

2. AC will decrease

So irrelevant whether margin is going up or down, just if the margin is above or below the average.
Minimum Average Costs
*The capacity point; i.e., the optimal level of production where output cannot be increased without increasing the average cost per unit.
*Where MC = AC (but low AC is not objective for being in biz, want to max. profit)
*Where the slope of the vector from the origin is equal to the slope of the TC function.
Supply is the derivative of...
Marginal Cost
Supply Curve
*Is a horizontal aggregation of the marginal cost functions past the point of diminishing returns for all of the member firms in a market. (Marshall)

*Supply Curve is the industry's MINIMUM PRICE LINE, because at each Q nobody will can sell below that P (for prolonged amount of time), will go out of biz.
Aggregate Supply
The total supply of goods and services by a notional economy during a specific time period.
Be able to draw:
Aggregate Supply Curve
Draw 3 graphs going from
DUOPOLY => TOTAL SUPPLY
(pp 16)
Ways to Change Supply
STGCS

1. Change size of existing firms in market
2. Tech advancement; e.g., if firm A has a tech. adv., MC of production shifts down, supply shift to right
3. Govenrment Inspection; ex. OSHA walks in, cost increase, supply shift left
4. Cost of raw material; supply curve shift left
5. Sales Tax increase; cost up and supply curve shift left
Elasticity of Supply
*AS curve is usually drawn as up-sloping in short-run, b/c quantity production supplied (Qs) rises as the average price level (P) rises.
*Elasticity is about QUANTITY (not S or D)
*Q = f(P)
Elasticity of Demand
Same as Elasticity of Supply
EXCEPT:
-replace QsubS with QsubD
-In Demand Theory, we made the assumption that the demand function is neg, linearly sloped, and extends to both axis.
-BUT SUPPLY CURVES
-Are positively sloped
-Are curvelinear
Draw a Supply Curve:
1. Normal Case (increasing cost)
2. Natural Monopoly (decreasing cost graph)
3. Constant cost graph
4. Fixed supply graph
See pp 17
Price Maker
*You are a price maker if you can change q.
*Price per unit item, is the same regardless of the number of units produced.
*Have constant MC
*On P v. Q plot, S is horizontal

*Example: A pencil company; Staples wants a discount but you can't give one b/c P is fixed (see graph pp 17 notes)

*Who determined price? Utility or Cost function => COST (PRODUCTION COST)
Price Taker
*You are a price maker if you cannot change q.
*Have fixed SUPPLY
*On P v. Q plot, S is verticle and lower value is DUMPSTER PRICE

*Example: Fresh Fish Monger has no say in price. They have the QUANTITY they caught in the morning and they will sell for whatever they can get (above DUMPSTER PRICE)... so PRICE TAKER
Point of Diminishing Return
18
Supply Curve of Labor
*Leisure Line
*Subsistance Line
*"S" shaped curve
*If you increase pay, increase responsibility

*REMEMBER if you go below Sub Level to and employees are behind you, don't abuse it. They will take TIME and you can't get it back.

See notes pp 18
What are the 3 time periods?
Long-Run
Short-Run
Momentary
Long-Run
The time it takes for all factors of production to be changed.

Examples:
*Fisherman to get new boat, new crew - 6 mo to 1 yr
*Steel Production - from groundbreaking to first bar of steel (~10 yr)
*Coffee - into the ground and out with the bean in 3 years
Short-Run
The time it takes to change some but not all factors of production.

Examples:
*Fisherman - more than a day to get a new crew and new nets
*Steel Production - 5 to 7 weeks to get new iron
Momentary
When the market supply is fixed

Example:
*Fisherman - less than 24 hours
Walrasian Equilibrium => Equilibrium Theory
Walras synthesis of two disparate mathematical concepts; i.e., supply and demand

Arguably the most important natural law in economics, whether applied to:
A market (partial eq - Marshall)
An economy (general eq - Keynes)
Partial Equilibrium
(Marshall) Equilibrium theory applied to one market (1 good, 1 time, 1 place) (price theory)

See notes pp 20
General Equilibrium
(Keynes) Eq. theory applied to an ECONOMY (National Income Analysis)

See notes pp 20
Legal Contracts
20
Legal Contracts - Historical Prospective
20
Contract
20
Elements of a Contract
21
Statute of Fraud
21
Types of Auctions
1. Auction with reserve
2. Auction without reserve
3. Dutch auction

(pp 21 of notes)
Auction with Reserve (an offer)
*Seller reserves right to influence price (rip you off)
*Can
-set min price
-use shill
-withdraw prior to end of auction

See notes pp 21
Auction without Reserve (an acceptance)
*Auctioneer must sell to highest bidder

See notes pp 21
Dutch Auction
*Reverse auction (begin high and come down)
*Good when necessary to auction quickly

See notes pp 21
Tax Incidence
*The ultimate burden of tax that could otherwize be used bo the buyer or seller elsewhere if there were no tax.
*"Falls" upon the group that bears the burden of the tax.
*Where tax falls depends on Supply and Demand curves
*Falls mostly on group that responds least to price (group w/ most inelastic P/Q curve)

See notes pp 22
Concept of the Ultimate Burden of Tax
*All taxes are shared (except in extreme conditions)

Notes pp 22
Incidence of Tax

T =
TsubD =
TsubS =
*Draw graph
T = TsubD + TsubS
TsubD = deltaP (or PsubT - Psub0)
TsubS = T - TsubD

Notes pp 22
T =
T = TsubD + TsubS
TsubD =
TsubD = PsubT - Psub0 = deltaP

or the change in price is the burden of the buyer

Tax paid by the buyer
TsubS =
TsubS = T - TsubD

Tax paid by the seller
Tax w/ Totally Elastic Supply
23
Ex. Pencil
TsubD = deltaP = T
TsubS = T - TsubD = 0
Tax w/ Totally Elastic Demand
23
Ex. Soft Coal
TsubD = deltaP = 0
TsubS = T - TsubD = T
Tax w/ Totally Inelastic Supply
23
Ex. Fresh Fish
TsubD = deltaP = 0
TsubS = T - TsubD = T
Tax w/ Totally Inelastic Demand
23
Ex. Salt
TsubD = deltaP = T
TsubS = T - TsubD = 0
Special Cases
1. Tariffs
2. Subsidies
3. Superstars
Tariffs
-Def.
-Who do they protect?
-Objective
-S & D HAVE to be...
*Def: A tax on imports (i.e., a customs duty)
*Protect the domestic producer
*Objective is to stop imports
*DRAW
*Need both relatively elastic, so both pay the tax
*If either S or D is rel. inelastic, policy will fail, neither will pay tax if inelastic

See pp 24 notes
Subsidies
*A unilateral transfer payment from the government to the business sector
*NEGATIVE TAX
*Ex. Chrysler gets subsidy to stay in business
*DRAW

See notes pp 24
Superstars
24
Interdependent Market
To the extent that a price change in one market affects either the supply or demand in another market, the two markets are said to be interdependent.
Substitution Good
Occurs when the use of one good precludes the use of another; i.e., they are mutually exclusive.

Example: Tea/coffee; Corn/peas in hail storm

DRAW (pp 25)
Complimentary Good
When the use of one good requires the use of another good; i.e., they are mutually dependent

Example: Corn/butter; chassis/wheel

DRAW (pp 25)
Factor Good
A good used in production of another good. When a change in market price of a good (e.g., autos) affects the market price of a factor good (e.g., steel), the two goods are said to be interdependent.

DRAW (See notes pp 26)

Ex. in a hail storm, demand for truckers goes down
Govenrment Intervention
-Gov. Paternalism
*Man-made laws written to counter natural laws (and violate Caveat Emptor)
*DRAW GRAPH

See notes pp 27
Caveat Emptor
*Latin for "let the buyer beware"
*In economics, encapsulates the essence of the market system (everyone responsible for their own actions)
*If the market is going to succeed in making it to the frontier line, everybody (buyers and sellers) needs to contribute their knowledge.

Ex. Russian Gov. failed b/c almost everyone was kept out of the decision process.
Consumer Protection
Ex. FDA will test food for bacteria (cost included in total food cost)

Ex. Drug testing - it takes about 10 years to release a drug (makes for increased costs)

pp 27
Income Redistribution
*The result of a change in gov policy whereby one group or sector is made better off by making another worse off
*These always backfire
*AKA - Robin Hood Scheme
pp 27
Black Market
An illegal transaction, the sale of a prohibited good or service; i.e., buying and selling of merchandise or services illegally.
Theory or Bureaucratic Displacement
(Gammon) The more bureaucratic an organization, the greater the extent to which useless work tends to displace useful work.
Parkinson's Law
Work expands to fill the time available for its completion.

Also, demand on a resource alwasy expands to match the supply of the resource.

The reverse is not true.
Wages and Price Control
pp 28
Fair Labor Standards Act
Created to prevent employers taking advantage of employees (pure fraud) during the Great Depression). Can't agree to work for less than a set minimum.

**GRAPH (pp 28 in notes)
Rent Ceilings
Rent Control
Dosent work
Minimum Wage
*Min wage causes increased unemployment
*DRAW GRAPH (pp28)
*Increasing min wage (when unskilled unemployment is greater than 4%) is not effective, just causes inflation w/o creating jobs.

pp 28
Profit Maximization in a Competitive Market
pp 29
Natural Law
pp 28
Perfect Competition
*Marshall's theory of markets demonstrating that an economy will eventually optimize the use of its scarce productive resources if no single firm can significantly affect the market price, goods are standardized, and there are no artificial barriers to trade.

pp 28 (in Primer)
Assumptions of Perfect Competition
1. Market Price (No single firm can sig. affect P); no collusion and P is horozontal
2. Homogeneity (standardized products or not differentiated)
3. Free Enterprise - Free entry and free exit
Assumptions of Perfect Comptition
pp 30 (MAKE SURE TO READ THIS ONE B/C IT IS LONG)
1. Market Price
2. Homogeneous Product
3. Free Enterprise
Behavioral Reality
*Assume in the model, that it is a comp. market
*What happens if the largest firm doubles production?
-Normally S shifts to right
-However, in perfect comp. mkt, no single firm can affect P, so P does not change
- S=S' & Psub0=Psub1
- Supply q0 to q1 but market Q0 stays same and Price stays the same
-For seller, D=AR=MR

pp 31
DRAW graph
List the Decision Points on a TC graph (Notes pp 32).

Hint: There are 5 points.
1. Shut-Down (TR = VC)
2. Break-Even (TR = TC)
3. Min MC (inflection pt on TC or VC)
4. Profit Max (MC = MR)
5. Min AC (MC = AC)
Shut-Down
Shutdown @ TR = VC

Where total revenue (TR) equals variable cost (VC)

(pp 32 of Notes)
Break-Even
Break-Even @ TR = TC

Where total revenue (TR) equals total cost (TC).

(pp 32)
Profit Maximization Point
Profit Max. @ MC = MR

Where marginal cost (MC) equals marginal revenue (MR)

(pp 32)
Perfect Competition Model
pp 34
DRAW 4 GRAPHS
1.
2.
3.
4.
Non-Competitive Markets
A. Monopoly and Monopsony
B. Monopolistic Competition (Chamberlin)
C. Price Discrimination (Joan Robinson)
pp 35
Monopoly (& graph)
*Operate where MC=MR
*There is no SUPPLY CURVE, supplier decides what quantity to bring to market
*There is a SUPPLY POINT
*A competitor believes the DEMAND function = MR = MC, and would operate at Qc
*Profit of Competitor = Pc-ACc
*Profit of Monopolist = Pm=ACm

See pp 35
Key aspects:
Demand, AR, MR, MC, AC, Supply Point, ACsubM, P(Q)subM, ACsubC, P(Q)subC, Consumer surplus, lost consumer surplus
Welfare Effects (1 => 5)
(From Pareto - the impact on consumers)
1. Higher Prices
2. Lower Quantity
3. Higher AC (departing from prod. poss. curve)
4. Higher Excess Profits
5. Lower Consumer Surplus

See pp 36 in Notes
Natural Monopolies
These should be encouraged because they will give lower costs to the consumer as they form. Once a monopoly is formed, regulate.

See pp 36
Anti-Trust Triology
REMEMBER 'SRC'
1. Sherman Act
2. Clayton Antitrust Act
3. Robinson-Patman Act

Know them all

See notes pp 36
Sherman Anti-Trust Act
* The 1890 law that makes monopolistic restraint of trade illegal. (see Anti-Trust Trilogy)

See notes pp 36
Clayton Anti-trust Act
* The 1914 law that authorized federal judges to issue preliminary injunctions when they hear evidence that the Sherman Anti-Trust Act has been violated. (see Anti-Trust Trilogy)

See notes pp 36
Robinson-Patman Act
* The 1936 law that forbids predatory pricing, price fixing, and other forms of collusion. (see Anti-Trust Trilogy)

See notes pp 36
Utility Commission
* A government agency, whose members, appointed by a governor, establish prices and services standards for natural monopolies such as water and power.

See notes pp 36
Raison D'etre
Reason to be; the basic reason to exist
pp 36
Monopolistic Competition
* Developed by Edward H. Chamberlin (Marshall did not consider these)
* Fall between the extremes of Perfect Competition and Monopoly
* Oligopoly, Oligopsony, Duopoly

See notes pp 36
Draw a graph of an Oligoploy and list the CAUSE and EFFECTS
CAUSE:
* Huge capital requirements OR
* Diminishing capital requirements

EFFECTS:
* Two demand curves
* Discontinuous MR curve
* Rigid prices

See notes pp 37
CAUSES of an Oligopoly and examples
1. Huge capital requirements
-Steel industry takes 15 yr to build
-Wide body air jet
-Pertoleum refineries
-Alminum mill (45billion to start)

2. Diminuous capital requirements (i.e., anyone can do it, cost of prod is low, cost of AD is high)
-Cigarette manufacturing
-Toothpaste
-Soft drinks

See notes pp 37
3 Types of Collusion
Collusion is when 2 or more firms act in consert to manipulate the market to their benefit, thereby adversely affecting the consumer.

1. Merger & Acquisition
2. Cartel
3. Price Fixing

See notes pp 38
Merger and Acquisition
* Type: explicit
* Legal Obstacle: Anti-trust trilogy; Anti-trust div. of US Justice Dept.
*Economic Obstacle: Friedman's entrepreneurial capacity constraint tends to destroy the company internally (e.g., merger between GM & Hughes, firms so conflicting, bad idea)

See notes pp 38
Cartel
* Type: explicit
* Legal Obstacle: America can't play; prevented by US laws
* Economic Obstacle: High cost of administration (e.g., OPEC oil cartel)

See notes pp 38
Price Fixing
* Type: implicit (covert)
* Legal Obstacle: Robinson-Patman Act - DO NOT EVER MEET WITH COMPETITORS
* Economic Obstacle: Everyone starts to cheat and chisel (e.g., airlines advertising legroom size)

See notes pp 38
Name the 3 Degrees of Price Discrimination and who developed them.
**MAKE SURE TO READ pp 39

Developed by Joan Robinson
1st - Perfect Price Discrimination
2nd - Quantity Discounts
3rd - Market Separation
a. Peak-Loading
b. Tie-In

See notes pp 39
First Degree
* AKA - Perfect Price Discrimination

* Elasticity of Demand (graph)
Seller will set different prices for each buyer; increase in price is advantageous if e<1; the seller gets more money for fewer goods.
* Consumer Surplus
Perfect price discrimination means the seller captures every bit of consumer surplus, right at the limit so each customer is a marginal customer

*Example: Ticket scalpers determine buyers MU/P standard and charge the most they can get.

See notes pp 39
Second Degree
AKA - Quantity Discounts
*Prices vary with quantity sold; larger quantity, lower unit price.
* As in 1st Degree, quantity discounts (or non-linear pricing) is a means by which suppliers use consumer preference to distinguish classes of consumers.

* Allows the seller to set different prices for different groups and capture a larger portion of the total market surplus.
* LEGAL - Supreme Court ruled this is legal
*EXAMPLE - Buy one, get one free

See notes pp 39
Third Degree
AKA - Market Separation
* The price varies by lovation or customer segment. The suplier of a market where this type of discrimination is exhibited are capable of differentiating between consumer classes.
* MOST FORMS ARE LEGAL
* EXAMPLE - Senior discounts
* TYPES: Time, Labeling, Geographic, Profit Potential

See notes pp 39
Joseph Alois Schumpeter
*Wrote the Theory of Economic Development - How to make a poor country rich
*Defined the 4th Factor of Production - Entrepreneurship
4th Factor of Production
See Notes
Remember 5 Characteristics
Know Schumpeter Growth Model
pp 50 in Primer
Laffer (the economist)
* Laffer Curve - Gov % GNP on y-axis, % GNP Growth on x-axis => get ~18% optimal
* Too low people can't take care of themselves
*Too high, there is no incentive
Fredreich Von Hayak
*57 Books
* U of Chi
* Says Adam Smith was right
-Private sector => create surplus
-Public Sector => remove surplus
*BOOK: Road to Serfdom
-Beurocracies grow to protect themselves, not b/c bad, but b/c spend money to get budget back

See Notes
Private Sector - Create surplus
Gov. - remove surplus
Road to Serfdom
Sean Kennety Galbrath
*BOOK: The Affluent Socitey
-As we get rich, we spend more money on things that are bad for the environment (Ex. AC, power steering => get smog)
*His work led to Nixon creating the EPA
* NEVER WON THE NOBEL
Paul Anthony Samuelson
* Harvard Grad
* Book: Economics - Became the standard for the world
* Dissertation: Fundamentals of Economic Analysis - was a great work, he filled the room during his defense.
* Won Nobel
Welfare Triangle
Vilfredo Pareto's description of consumer surplus. (see consumer surplus)
Market
All the potential buyers and sellers of a particular good or service. (see market price)
Market price
The competitively arrived at price of one good, in one place, at one time.
Giffen Good
Inferior good: A good that is bought in smaller quantities as real income increases, or vice versa; a Giffen good. (see superior good and reverse income effect)
Consumer Price Line
The average revenue (AR) function; the demand curve.
Price Discrimination
The act of inducing different buyers to pay different prices for the same good.
What does a firm want to maximize?

And what would be rediculous?
A firm wants to maximize PROFIT, not total revenue.
Elasticity of Demand
A reflection of the responsiveness of consumers to a price change.
If a decrease in price is more than offset by an increase in units sold (i.e., TR has a net increase), Demand is said to be...
Relatively elastic (pp 37 in Primer)
Where is max TR in the Elasticity Summary graph on pp 39 of the primer?
At the point where the curve is unit elastic (i.e., e = -1)
What is the mathmatical imperative that allows us to determine elasticity in the graph on pp 39 of the primer?
The demand function is:
1. down-sloping
2. linear
3. extends to both axis
When demand is unit elastic, what does MR equal?
MR = 0
(pp 40 section 7 in Primer)
If the demand curve is linear and horizontal, i.e., totally elastic, what does this suggest?
This suggests the availability of close substitutes (competitive supply).

TR is the same regardless of quantity sold, i.e., no drop in price would ne needed to increase sales (MR = D = AR = P)
Where would the following be on the Decision Point graph (pp 32 of Notes)?
1. Venture Capitalist
2. Marketing & Sales
3. Inventor
4. Us
1. Venture Capitalist => Past shut-down ASAP
2. Marketing & Sales => Max TR point
3. Inventor => Lowest point on MC curve
4. Us => Max Profit @ MR = MC (just before max TR)
What is a shill?
A shill is an agent of the seller. At an auction, they will bid to some set minimum price without the other buyers knowing.
List the 4 extreme conditions where tax incidence is not shared.
1. Totally elastic supply (pencils)
2. Totally elastic demand (soft coal)
3. Totally inelastic supply (fresh fish)
4. Totally inelastic demand (salt)

Know who pays the tax:
TsubD = delta P
TsubS = T - TsubD
Peak-Load Pricing
A legal form of price discrimination whereby buyers pay more during periods of high demand; e.g., airlines or telephones
Tie-In Sales
A transaction whereby the inital sale (usually low-priced) requires an additional purchase of related goods or services only from the original seller; e.g., Polaroid cameras, video game systems, or home alarm services.
Homogeneous Products
Goods standardized by government regulation or industrial convention. (see differentiated products)
Differentiated Products
Competitive goods made different by physical characteristics or distinguished by advertising. (see homogeneous product)
If the price elasticity of demand were less than 1, the good would be called what?
A necessity good
If the price elasticity of demand were greater than 1, the good would be called what?
A luxury good
Fixed Supply
Totally inelastic supply; i.e., the quantity supplied remains the same regardless of price. (see price taker)
Who is responsible for the Negative Income Tax concept?
Milton Friedman
What restricts Monopolies?
Government regulation (i.e., the Anti-Trust Trilogy)
Define the following:
D, S, E, π
D - All of consumer behavior and how they react

S - The behsvior of the seller/supplier

E - When you bring S & D together, you get Equilibrium Theory (Walras)

π - Profit Theory (How to make money)
Cardinal Number
A number with a specific value
Ordinal Number
Numbers that assign rank; i.e., first, second, or tenth
Satiation
Maximum Total Utility

OR

Where MU = 0
What is the approximate Welfare Triange (aka consumer surplus) that the USA has captured?
~40% to 50%
Why are indifference curves convex?
Because of the Law of Substitution.
How do you get above your budget constraint?

Below the line?
Above - Criminal

Below - Burn your money
What is the exception to the ASSUMPTION of TRANSITIVITY for an INDIFFERENCE CURVE?
Voter's Paradox

http://en.wikipedia.org/wiki/Voting_paradox
Demand vs. Effective Demand
Demand is the whole function

Effective demand is about the CURRENT PRICE
DO NOT PUT A PRICE NOTATION ON A QUANTITY AXIS.
Prof did this in class when he was explaining REVERSE SUBSTITUTION EFFECT, but said not to.

See notes pp 8
Theory of the Leisure Class
*First marketing book
*From Thornstein Veblen
*Explains REVERSE SUB. EFFECT
Reverse Substitution Effect
*Happens when good is rel. elastic

Ex. Corefam Shoe
*Cheap to make for DuPont
*Sold expensive
*Eventually lowered price and couldnt sell a shoe
*VERY RARE

Ex. 2 - Chivas Regal Blended Scotch
*High price and people buy, but it is crap
*If they lower the price, it will tank.
*People think there is some UTILITY in the PRICE
Reverse Income Effect (Giffen Good)

??Inferior good??
*Happens when a good is rel. inelastic
*Giffen discovered this in Ireland during potato famine
*Price decreases BUT Quantity purchased decreased too
*WHY? Because the drop in Price was enough to increase the REAL INCOME and allow them to buy veggies and meat.

*Example: Irish Potato Famine
Abnormal Goods
(Give 2 Explainations for them)
Goods that disobey the law of Demand
1. Reverse Income Effect - relatively inelastic e<1 (necessity)
2. Reverse Substitution Effect - relatively elastic e>1 (luxury)

*See Dr. G Slide #27
How do you change the QUANTITY DEMANDED?
*Changing the Price will change the quantity demanded.
*THIS WILL NOT CHANGE DEMAND!!
Demand Shift
Change in price DOES NOT change Demand, it changes location on the demand curve which makes the demand observable in the real world... But the demand was always there.
Derive a Positively Sloped Demand Curve
See Dr. G's Slide #27
Are Slope and Elasticity inversly related?
NO. Slope and elasticity are only opposite at the EXTREMES

EXTREMES:
* e = infinity; slope = 0
* e = 0; slope = infinity

IGNORE SLOPE WHEN WORKING WITH ELASTICITY
Revenue is about Demand => Example
Ex. Nordstrom says customer always right. It costs them $700 to get a new customer. More importantly, the DEMAND OF THE CUSTOMER DRIVES REVENUE.

*Money comes from the customer and consumer drives revenue
Objective for being in business?
Objective is to MAXIMIZE PROFIT
Rediculous objective for doing business?
*Maximizing REVENUE (not PROFIT)

*This was done to teach Revenue Theory

See pp 37 in Primer
If maximizing REV (not Profit) and Demand is:
1. rel. elastic
2. rel. inelastic
3. unit elastic
1. Demand is rel e
*lower P a little and get a lot of new customers
*P(went down a little) x Q(went up a lot) => PxQ increased

2. Demand is rel inelastic
*Raise P a lot and only lose a few customers
*P(increase a lot) x Q(decrease a little)
*So, PxQ increases

3. Unit elastic
*You are perfect
When you find the AC (by dividing the height by the quantity), you also find the slope of the vector. If the vectors are pivoting down, then what is happening to AC?
AC is also decreasing.

Also know that MC = AC here.

See notes pp 15
***What is the objective of...
1. Inventor
2. Manufacturing
3. Sales Guy
1. Pt of diminishing return; Min on MC function - He wants everything to be perfect and 'right'

2. Low price producer; Min AC

3. Largest Market Share; try to MAX REV
Give an example of LOW COST PRODUCER (Min AC)
Ex. Delorian made cheap cars, but nobody bought them, so low cost is not how you run a biz.
Natural Monopoly
&
Describe Stages of Nat. Mon.
*This is a DECREASING COST INDUSTRY and will ultimatly become a monopoly.

STAGES:
1. Bigger company has lower costs and higher sales
2. With profit, buy competitors
3. Eventually saturate the market and form Monopoly when down to one company in an industry
4. Then Govenrment should come in and regualte
What causes the POINT OF DIMINISHING RETURNS in a Natural Monopoly?
*Entrepreneurship becomes an issue (and VICE VERSA because low guy can't make a change)
*There needs to be one person with clear vision that can relay enthusiam and drive through the company
*If too big, this is almost impossible
*Ex. Suggestion box @ Watson
*For VICE VERSA - the employee makes a suggestion in a BIG company, but it costs money, and middle Mgmt won't want to spend b/c want promotion
See notes pp 18
# of people you can change in a day:
1. lower lever supervisory
2. Middle management
3. Top Mgmt
4. Fortune 100
5. Best of the Best
1. 2 - 3 people
2. 5 - 6
3. 7
4. 8 - 9
5. 10

Need personality and communication skills to be able to talk to someone and make them get things done.
EXAMPLE OF ENTREPRENEURSHIP IMPORTANCE

The American Biz Model is typically...

Watsons...
American = Military Model

Watson = no more than 7 people between top and bottom
Legal Contracts (Man-Made Law)
*Developed to enforce appropiate behavior
*In biz, we have NATURAL LAWS that are hindered by MAN-MADE LAWS
Historical Prospective on Law
*Hammurabi - (1728-1686BC) The first codification of law
*Romans - Roman Code Law was developed for all regions under Rome
*Europe Civilizations - Based on Roman Code Law
*Naploeon Bonaperte (SEE NEXT SLIDE)
*James Madison (SEE NEXT SLIDE)
*UCC (uniform commercial code) - 1st effort to develop a common code across US for COMMERCIAL LAW (Ranks 3rd in authority)
Napoleon Bonaparte (LAW)
*Greatest bureaucrat that ever lived
*Metric system
*Wrote Roman Code Law into Napoleonic Code
*70-75% of world uses Nap Code
*Called Francophile Jurisprudence because came from Paris
*The code is highest law in courtroom
James Madison (LAW)
*Wrote US Constitution to protect the PEOPLE from the GOV. because we know GOV will become corrupt (adopted 1789)
Contract
An enforcable agreement; i.e., an understanding between two or more parties that entitles an agrieved party to present a dispute to the trier of fact in a court of law.

Really, just something to show "a meeting of the minds"

NOTE: UCC requires land related transactions to be in writing.
Elements of a Contract
1. Offer (proposal)
-Good till withdrawn (clearly)
2. Acceptance (affirmative notification)
-Say 'yes' then be quiet, an acceptance should have nothing associated with it.
3. Consideration (quid pro quo)
-Don't ever accept an item for free, attach a dollar to stay out of trouble.
Two arguments why government doesn't want consumers involved in Economic decision processes?
1. Consumer Protection
2. Income Redistribution (Robin Hood Scheme)
Define:
1. Unskilled Labor
2. Skilled Labor
3. Semi-skilled Labor
1. Unskilled Labor - learn the trade in under 90 days
2. Skilled Labor - learn the trade in 3 years
3. Semi-skilled Labor - learn the trade between 90 days and 3 years
Two extremes of a competitive market?
1. Competitive
2. Monopolistic

*Marshall thought eventually there would be no inbetween
Natural Law
*A rule of conduct inherent in man's nature and discoverable by reason alone
*A law of social science
Natural Laws of Economics
1. Hedonism (seek pleasure, avoid pain)
2. Theory of Absolute Advantage
3. Theory ofComparative Advantage
4. Law of Diminishing Returns
5. Law of Diminishing Marginal Utility
6. Economic Rent Doctrine (surplus value is captured by the scarcest factor)
7. Law of Demand
8. Law of Supply
9. Law of Comparative Elasticity
10. Law of Supply and Demand
Market Place Continuum
*Extremes:
Perfect Comp. vs. Monopoly/Monopsony

*Assumptions of Perfect Comp.
1. Market Price
-No single firm can significantly affect P
-no collusion
-D is Horozontal
2. Homogeneity
-Standardized products (not differentiated)
3. Free Enterprise
-Free entry and free exit
Objective when you are running a country?
*You must operate at optimal output or min AC (dictator approach)
*If Gov. gets out of the way, competitors will beat each other up to get to this point b/c this is where they survive
*Result is CONSUMER SURPLUS
Define:
1. Monopoly
2. Monopsony
3. Oligopoly
4. Oligopsony
5. Duopoly
6. Natural Monopoly
1. Monopoly - Single seller (ex. gov buying subs)
2. Monopsony - Single buyer facing many sellers (ex. small town dominated by 1 employer)
3. Oligopoly - A market with few sellers (ex. baby food, credit cards, batteries, auto manf.)
4. Oligopsony - A market with few buyers (ex. US Fast Food)
5. Duopoly - Two producers
6. Natural Monopoly - A decreasing cost industry (eventually become monopoly - Ex. utility)
Define:
1. N
2. NsubF
3. NsubU
1. N - Employment Level
2. NsubF - Full Employment
3. NsubU - Unemployment
What are 2 ways to have homogeneous products?
1. Government regulation
2. Industry convention
Free-Entry
*Absence of artificial (non-economic) barriers to entering the market
*Ex. IP law, patents, copyrights, trademarks, crime, tariffs, licenses, Org. crime
Free-Exit
The absence of artificial (non-economic) barriers to leaving a market
*Ex. Gov regulation, union contracts, legal injunction