Economics: Understanding Imperfect Markets, Externalities, and Labor Markets, Study notes of Microeconomics

Download Economics: Understanding Imperfect Markets, Externalities, and Labor Markets and more Study notes Microeconomics in PDF only on Docsity! Econ 201 Review Notes - Part 3 This is intended as a supplement to the lectures and section. It is what I would talk about in section if we had more time. After the first three chapters where we talked about rational decision makers; what they do and how they should make decisions, what happens when one individual interacts with another, and finally when many individuals interact together in a market. Next, we looked more closely at markets and how economists describe them and what they tells us. We looked at the demand side of the market (consumers), the supply side of them market (producers/sellers) and then talked about how the market induces outcomes that are efficient. Now we want to talk mostly about what happens when things aren't as perfect as in the simple model of perfect competition. But before that we want to talk about what competition does and the concept of the invisible hand. Then we will talk about markets where there does not exist perfect competition but rather imperfect competition. Finally we will talk about externalities, labor markets, information and governments. 7. The Invisible Hand The central concept that that when, in a perfect world, people act in a purely self- interested way, an efficient outcome arises. But first what is self-interested? Well for firms it is profit maximization. To study this, it is necessary to understand what economists call profit and how that differs to the way you are probably used to thinking about it. A. Accounting Profit: This is what you are probably used to, this is simply the revenue taken in by the firm minus all of its explicit costs. This is what an accountant would report, or what is recorded in the firm's books. B. Economic Profit: This is different: This is the revenue minus all explicit costs and all implicit costs (opportunity costs). C. Normal Profit: Is simply the amount of accounting profit which exactly covers opportunity costs, it is the same amount as the opportunity cost. Why this difference in definition? Because economists are concerned with the decision to begin or remain in business and we figure that in order to do so, a businessperson must be doing at least as well in their business as they would doing the next best job available to them. If not, they should go out of business and take that job. When there is perfect information in an economy, prices play a vital role, and more than you might think on first glance. D. Rationing Function of Price: Prices serve as a method of screening out potential buyers who do not value an item as much as others. E. Allocative Function of Price: Prices lead businesspeople to search for underserved markets (high prices) and avoid overserved markets (low prices). For these wonderful things to happen, information must be free and available to all and competition must be perfect. When is competition not perfect? When there are barriers to entry. F. Barriers to Entry: Something (like a patent or copyright) that prevents new firms from entering a market. 8. Imperfect Competition So what if there are barriers to entry, what then? We call this imperfect competition and talk generally about three broad categories monopoly, oligopoly, and monopolistic competition. These are all types of price setters. A. Price Setter: a firm who faces a downward sloping individual demand curve. B. Pure Monopoly: A firm that is the only supplier of a unique product. C. Oligopolist: A firm that produces in a market with only a few competing firms. D. Monopolistically Competitive Firm: A firm that produces in a market with many competitors, but who is able to differentiate its product from the others. All of these types have market power: or the ability to raise prices without loosing all of their sales (because of the downward sloping demand curve). In all cases the firms try to maximize profits and in order to do so, follow a simple rule, set output such that marginal revenue = marginal cost. Note that this is the same rule as perfectly competitive firms follow except that for competitive firms MR=Price. Because of the downward sloping demand curve, when imperfect competitors follow this rule the outcome will no longer be socially efficient. In fact, they will produce too little than is socially optimal. Imperfectly competitive firms can do better if they price discriminate. E. Price Discrimination: Different prices are charges to different consumers based on the consumers reservation prices. If a firm can perfectly price discriminate, or charge each individual consumer their reservation price, then the efficient outcome is restored, but with all of the surplus accruing to the firm.