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EC120 Final Review Notes.docx

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Wilfrid Laurier University
Peter Sinclair

Chapter 10  Externality: the effect of one's actions on the well-being of another o Can be positive or negative  Market outcome is not socially efficient due to self-interested buyers and sellers  Negative externality: market equilibrium is more than socially optimal quantity  Positive externality: market equilibrium is less than socially optimal quantity  "Internalize the externality" (government intervention): alter incentives to achieve socially optimal outcome o If negative: tax goods (Pigovian taxes) o If positive: subsidize goods  The Coase Theorem (private solution): private parties can solve the externalities problem on their own, provided there is no cost involved  Problems: o Transaction costs o Parties may hold out for a better deal o Co-ordination problems (if the number of parties involved is very large)  Public Policies: 1. Command-and-Control (regulation) 2. Market-based policies o Pigovian taxes and subsidies o Tradeable permits Chapter 11  Excludable good: a person can be prevented from using it  Rival good: one person's use diminishes that of another  Private good: excludable and rival (i.e. ice cream cone)  Public good: neither excludable nor rival (i.e. national defence)  Common resources: rival, not excludable (i.e. fish in the ocean)  Natural monopoly: excludable, not rival (i.e. fire protection)  Free rider: a person who receives the benefit of a good without paying for it o If a good is not excludable, people have incentive to be free riders because they cannot be prevented from using it o As a result, the good will not be produced  Tragedy of the Commons: o Common resources get used more than is socially desirable o Private incentives outweigh the social incentives Chapter 15  Monopoly: sole seller of a product, no close substitutes o Has market power (competitive firm does not)  High barriers to entry cause monopolies, three sources for these barriers: o Single firm owns key resource o Single firm has exclusive right to produce the good o Single firm can produce entire market quantity at lower ATC than multiple firms (natural monopoly)  Competitive firm has a horizontal demand curve at the market price (MR = P)  Monopolist has the market demand curve (MR < P)  Monopolists Marginal Revenue: o Output effect: more output sold, revenue increases o Price effect: price decreases, causing revenue to decrease o Maximize profit by producing quantity where MR = MC  A monopoly has no supply curve  Monopoly results in a deadweight loss (P > MR=MC)  For natural monopolies, MC < ATC at any quantity, MC pricing results in losses o Subsidizing MC pricing means higher taxes, creates its own DWL o Set P = ATC, price no longer reflects MC; not efficient, results in DWL  Public ownership is less efficient than private ownership o No incentive to minimize cost  Best policy when dealing with monopolies is no policy  Price discrimination: o Perfect price discrimination (charging based on each buyer's WTP) is unrealistic o Second-degree price discrimination (different prices based on quantity) makes more sense o Third-degree price discrimination (segment markets based on elasticity of demand) is the most feasible Chapter 16  Monopolistic competition: many firms sell products that are similar but not identical  Downward-sloping demand curve  MR < P at any quantity  In the short run, monopolistic competition and monopoly have similar behaviour  In the long run, entry and exit drive economic profit to zero (like perfect competition)  Monopolistic Competition vs. Perfect Competition: o Monopolistic competitor produces less than cost-minimizing output o Perfectly competitive firms produce quantity that minimizes ATC o Monopolistic competition, P > MC, market quantity < socially efficient quantity o Perfect competition, P = MC  Product-variety externality: consumer surplus increases from introduction of a new product  Business-stealing externality: firms lose customers and profits because of new firms  Advertising: o The more differentiated the products, the more advertising firms buy o Advertising promotes competition and reduces market power o Willingness to spend large amounts on advertising acts as a signal of quality (must lead to repeat buyers) Chapter 17  Oligopoly: few sellers, offer similar or identical products  Co-operative outcome: firms in oligopolistic market work together to produce monopolistic output and maximize joint profits o Any individual firm can make more profit by reneging on agreement  Collusion: agreement between firms about quantities to produce and prices to charge  Cartel: a colluding group of firms  Nash Equilibrium: each e
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