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Second Half - Final Exam.pdf

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ECON 1131
Richard Tresch

  Tsuruta  1   Chapter  9  (Labor  Markets)     The  Supply  and  Demand  for  Labor   • How  much  labor  will  be  supplied  to  a  given  labor  market  at  different  wages   OTE?   • Consumer’s  Modified  Economic  Problem:  how  much  to  work:  select  the   combination  of  work  and  leisure  that  yields  the  maximum  amount  of   satisfaction     • The  Individual  Supply  Curve:  How  much  time  does  a  representative  individual   want  to  work  at  different  wage  rates?     o Shape  depends  on  substitution  and  income  effects  of  wage  change     o Supply  curve  need  not  be  upward  sloping  –  sub  and  income  effects  tug  in   opposite  directions  on  desire  to  work     § Sub:  Wage  rate  defines  rate  of  trade  between  income  and  leisure;   favors  additional  hours  of  work;  causes  labor  supply  curve  to  be   upward  sloping  –hours  of  work  increase  as  wage  increases  and   decrease  as  wage  decreases   § Income:  increase  in  wage  increases  purchasing  power;  causes   labor  supply  curve  to  be  downward  sloping;  hours  of  work   decrease  as  the  wage  increases  and  increase  as  the  wage   decreases     § Upward/Downward  depends  on  relative  strength  of   substitution  and  income  effects     • Value  of  time     o Price  of  a  product  vs.  Full  Price  of  a  product     § Full  price  includes  value  of  time  spent  shopping  for  product  and   consuming  it     o Women  in  work-­‐force     • Overall  Market  Supply  Curve   o Aggregate  of  individual  supply  curves:  indicates  overall  labor  force   participation  for  nation  (U.S.  curve  nearly  vertical)     o Supply  to  particular  occupation     • Demand  for  Labor     o 1)  Demand  curve  facing  firm  is  perfectly  elastic  at  P e   o 2)  Firms  supply  output  where  MR  =  MC  (firm’s  supply  curve  =  MC   curve)   o 3)  Upward  sloping  curve  in  short  run  bc  of  Law  of  Diminishing  Returns     o Supply  for  labor  for  firm  is  perfectly  elastic  at e W   o Firm  will  hire  labor  until  wage/MC  =  MR  from  hiring     o ***continue  economic  activity  until  MB  =  MC   • Marginal  Product  of  Labor  (MP ) L–  the  additional  physical  output  produced  by   each  additional  unit  of  labor     • Value  of  Labor’s  Marginal  Product  (VMP )   L o VMP =  MPL   L   g  *  e  P g  price  of  good/service  produced  by  labor   o Demand  for  labor  is  value  of  labor’s  marginal  product  because  farmer   hires  quantity  of  labor  at  which  e    VMP L       Tsuruta  2   o A  competitive  firm’s  demand  curve  for  labor  is  expected  to  be  downward   sloping  in  the  short  run    -­‐  Law  of  Diminishing  Returns:  marginal   (physical)  product  of  labor  eventually  declines  as  more  workers  are   hired     o VMP =  MP L    P L * output     • Market  demand  curve  for  labor  is  horizontal  summation  of  all  individual  firms’   demand  curves  for  that  labor     • Labor  Market  Equilibrium     o Where  market  supply  and  market  demand  meet     o If  W  >  W e  there  is  excess  supply   o If  W<  W  teere  is  excess  demand     • Competition  is  a  free  flow  of  resources   o Equal  opportunity/access  when  market  is  competitive   o You  get  horizontal  equity  (equal  treatment  of  equals)   • A)  1.    Identical  People,  Identical  Jobs:  competition  is  equalizer  in  market   economy.  Equal  accessà  equality  of  end  results.  Competitive  marketplace   achieves  horizontal  equity  –it  treats  identical  individuals  and  identical  business   firms  identically.  Competitive  labor  markets  tend  to  equalize  the  wages  of   identical  individuals  within  each  occupation  –  Farm  example              2.  Identical  People,  Jobs  Differ:  Jobs  differ  in  their  educational   requirements  and  attractiveness  (constancy  of  employment,  probability  of   success,  amount  of  responsibility,  working  conditions).  Equalizing  Wage   Differential:  a  difference  in  the  wages  for  different  jobs  that  just  compensate   workers  for  the  relative  attractiveness  of  the  jobs  –  there  are  lasting  wage   differences  because  people  can’t  move  to  a  different  occupation  due  to   skills/education  levels.  (i.e.  differences  in  formal  educational  requirements  and   hazardous  working  environments)     • Competitive  markets  still  treat  equal  people  equally,  but  in  terms  of  overall   satisfaction,  not  wages  -­‐  equalizing                                        3.    People  differ,  Jobs  differ:  When  both  people  and  jobs  differ,  overall   market  for  labor  divides  into  a  number  of  separate  noncompeting  labor  markets  –   people  are  no  longer  willing  or  able  to  move  from  one  occupation  to  another.  Unequals   can  be  treated  very  unequally.  Economic  Rent:  the  difference  between  the  wage  a   worker  receives  and  the  wage  required  to  attract  the  worker  to  the  job,  the  reservation   wage.  (i.e.  those  who  don’t  mind  working  at  night,  work  at  night  plus  get  25%  more)                           Tsuruta  3       Personal  and  Job  Characteristics   Market  Result     • People  Identical,  jobs  identical   • Everyone  earns  same  wage   • People  identical,  jobs  differ  in   • Equalizing  wage  differentials   desirability  or  skills  required   occur  across  occupations,  all     people  are  equally  well  off  (same     level  of  utility)   • People  differ,  jobs  differ   • Noncompeting  labor  markets   form,  wages  are  determined  by   supply  and  demand  in  each   market,  Identical  people  receive   the  same  level  of  utility,   nonidentical  people  earn   different  amounts  of  economic   rent         VMP  Lnd  the  Distribution  of  Wages     • VMP = L  P L  *   g • MP L –  Marginal  Product  of  Labor:  skills  and  productivity  of  workers,  number  of   people  who  possess  a  particular  skill     • P g  –  Price  of  Product:  indicates  that  the  demand  for  labor  is  a  derived  demand   (depends  in  part  on  market  for  the  product  that  the  workers  are  producing),  the   higher  the  price  of  the  product,  the  higher  the  wages,  OTE  (i.e.  Physicians  versus   Academics-­‐  demand  for  medical  care  shifted  out)     •  What  determines  competitive  wages?  (1)  productivity  or  skills  (2)  number  of   workers  who  are  willing  and  able  to  enter    given  occupation  (3)  market  for  the   good  or  service  being  produce       Chapter  21    -­‐  Role  of  Government   Strengths  of  Market  Economy/Capitalism:   1) Freedom  –  gives  individuals  and  firms  the  freedom  to  pursue  their  on  self-­‐ interests  and  solve  their  economic  problems  as  they  see  fit,  not  directed,   decentralized   2) Orderly-­‐rather  than  chaotic   3) Responsiveness  –  competitive  markets  are  responsive  to  the  desires  of   consumers,  prices  and  profits  are  mechanism  to  guide  firms  to  what  consumers   want     4) Potential   a. Efficiency  –  efficient  allocation  of  scarce  resources,  full  employment  of  all   productive  resources       b. Equity  properties  (by  definition  of  competitive  market  in  long  run  we   have  horizontal  equity  where  equals  are  treated  equally)     • Government  intervention  justified  only  on  basis  of  market  failure  in  US         Tsuruta  4     The  Government  Sector  in  the  Industrialized  Market  Economies   • 3  Branches   1) Distribution  (Equity)   • Government  intervention  always  justified  in  name  of  market   failure   • Goal  of  achieving  fair  and  evenhanded  market  exchanges  and  an   acceptable  distribution  of  income     • A)  End-­‐results  Equity   • B)  Process  Equity  (equal  opportunity,  social  mobility)   o All  societies  have  haves  and  have  nots   o People  like  distribution  of  income?   § Is  it  acceptable   § The  market  will  determine  the  distribution  of  income   § But  will  people  like  it   o Unequals  can  be  treated  very  unequally     § Tax,  transfer  payments  –  gov’t     § Entitlements,  social  security  –  gov’t     § “War  on  poverty”   o If  there  is  an  inequality,  government  has  to  step  in  or  else   market  won’t  fix  it  for  a  very  long  time     o Just  because  they  can  doesn’t  mean  they  will.     2) Allocation  (Inefficiencies)   • Market  Problems  –  almost  never  perfectly  competitive,  someone   knows  information  that  another  person  doesn’t     • Technical  problems  –  incomplete  markets  (insurance),  externalities,   public  goods     1) Natural  Monopolies:  single  firm  can  supply  entire  market   demand  most  cheaply:  single  seller,  firm  is  the  market:  large  start-­‐ up  costs  relative  to  lower  operating  costs     • Will  you  let  them  operate  as  a  monopoly?...  no  –   government  or  private  investors   • Where  do  you  find  it?     o Public  utilities:  electricity,  water   o Transportation:  subways,  highways,  bridges,  mass   rail  transits   o Recreational  Facilities:  parks,  beaches   o Telecommunication:  Software  TV   2) Externalities  (can  be  good  or  bad)   • Third  party  effect  of  a  transaction  that  directly  affects   either  consumer’s  satisfaction  or  firms’  production   possibilities  –  people  who  are  affected  have  no  direct   connection  to  purchase  and  sale     • Bad:  paper  products,  production  leads  to  pollution,  social:   what  it  costs  to  produce  adds  MC  of  pollution,  how  many     Tsuruta  5   people  are  damaged?   • Do  people  have  incentive  to  do  something  about  pollution?   o Only  if  everyone  else  cares   o Government  intervention   o 70s  -­‐  federal  government  (Clean  Air  Act)     o Good:  Mandatory  public  education     • Ultimate  Externality:  non-­‐exclusion  good  :  a  good  such  as   national  defense  that  is  consumed  by  everyone  once  any   one  person  or  the  government  buys  it;  no  one  can  be   excluded  or  exclude  themselves  form  consuming  the  good     • Serious  damage  to  goal  of  economic  efficiency  –   maximizing  wrong  net  value     • Pollution  –  Marginal  Cost  to  paper  producers  vs  Marginal   cost  to  everyone  in  society   • Education  –beneficial,  external  economy;  mandating   minimum  level  of  primary  and  secondary  education;   subsidizing  private  education   3) Stabilization     4) Free  Rider  Problem:  people  who  consume  a  non-­‐exclusive  good  without   paying  for  any  of  the  costs  of  the  good     a. Incentive  to  free  ride  destroys  normal  incentive  to  engage  in  market   exchanges  (i.e.  no  one  shipping  company  wants  to  pay  for  a   lighthouse  that  all  the  other  companies  will  benefit  from  –  hence  they   are  publicly  provided)     5) Information   a. Private:  businesses  have  information  about  themselves  that  others   can’t  know  –  asymmetric   b. Gas  Station  Example:  How  do  you  know  if  you  actually  got  10  gallons   of  gas?   c. Health  Inspections/  Insurance?   i. Large  numbers,  variability,  EO  :  AO   ii. Statistically  independent  events   iii. Good  Information   d. Leads  to  2  problems:   i. Moral  Hazard:  We  can  change  our  own  odds,  How  do   insurance  companies  protect  themselves?  When  individuals   who  are  being  insured  can  influence  the  probability  of  the  event   being  insured  against,  unbeknownst  to  the  insurer.  (i.e.  quitters   falsely  claiming  that  they  were  temporarily  laid  off,    Medical   insurance  –  companies  cant  control  how  much  people  smoke)     ii. Adverse  Selection:  pool  of  people  –  some  are  low  risk,  others   are  high  risk,  want  to  know  what  risks  are,  can  only  offer  1   premium,  low  risk  people  begin  to  drop  out,  high  risk  more   adverse,  keep  raising  premiums;  when  insurance  company  is   forced  to  set  one  premium  because  it  cannot  distinguish     Tsuruta  6   between  high-­‐risk  and  low-­‐risk  individuals,  with  the  result  that   low-­‐risk  individuals  cancel  their  policies.     iii. Principal  Agent  Problem:  principal  –  insurance  company   would  like  to  know  everything  about  the  risk  of  the  agents,   those  being  insured,  so  that  they  can  write  profitable   insurance  policies.  An  informational  problem  in  which  one   individual  (the  principal)  tries  to  monitor  and  control  the   behavior  of  another  individual  (the  agent),  but  does  not  have   enough  information  to  do  so,  and  the  two  individuals  have   different  goals.       Chapter  11     Total  Cost  of  Production   • Total  cost  curve  –  indicates  the  total  cost  of  producing  each  level  of  output  the   firm  might  choose  to  produce     • Long-­‐Run  Total  Cost  Curve  (LRTC)  –  OTE  relationship  between  output  and   total  cost  in  the  long  run     • Short-­‐Run  Total  Cost  Curve  (SRTC)  –  OTE  relationship  between  output  and   total  cost  in  short  run     • Marginal  Cost:  slope  of  total  cost  curve  at  each  level  of  output,  change  or   increase  in  total  cost  from  producing  one  additional  unit  of  output     • Shape  –  upward  sloping     o Increasing  at  an  decreasing  rate  from  0  to  10,  increasing  at  an  increasing   rate  from  10  on     • Long  run  –  all  factors  of  production  variable,  can  hire  no  factors  of  production   and  incur  no  costs  –  starts  at  origin   • Short  run  –  one  fixed  variable,  cost  associated  with  purchasing  fixed  factors  are   fixed  –  SRTC  =  FC  +  SRVC     • Fixed  Cost:  cost  associated  with  the  fixed  factors  of  production   • Variable  Cost:  cost  associated  with  the  variable  factors  of  production     • SRC  =  FC  +  SRVC,  LRTC  =  LRVC   • Additional  Characteristics:  (1)  time  dimension    (2)  OTE  (3)  Cost  as  Opportunity   cost  (4)  Representation  of  production  efficiency     o Total  cost  is  a  flow  variable  –  rate  of  production  over  specific  amount  of   time   o Total  cost  depends  on  number  of  variables  (i.e.  output,  factor  prices,   taxes,  available  production  technologies)   § TC  curve  assumes  all  factors  besides  output  that  affect  total  cost   are  being  held  constant   § Changes  in  any  other  variable  represented  as  shift  up  or  down  of   entire  curve     • Total  Economic  Cost:  for  any  given  output,  the  total  opportunity  cost  of  the   factors  of  production  used  in  producing  and  selling  that  output   o Operating  expenses,  explicit  monetary  costs,  nonmonetary  operating   costs,  depreciation  (  not  in  class  notes)       Tsuruta  7   o Opportunity  cost  of  capital:  the  return  that  owners  of  the  firm  could   earn  if  the  value  of  the  capital  they  own  were  invested  in  their  next  best   investment  alternatives     • All  cost  curves  derived  by  TC  curve   • If  time  permits,    read  p  255     Total  Cost  Curve  and  Economic  Efficiency   • Points  on  total  cost  curve  depict  the  best  possible  relationship  between  output   and  total  cost  at  every  level  of  output     • Total  cost  curve  is  an  efficiency  frontier  for  the  firm     if  time  permits  read  258-­‐260   Least-­‐Cost  Production  Rule     • To  solve  How  problem  firm  computes  MP /P F forF  each  of  its  factors  of   production,  then  adjusts  the  amount  of  each  factor  until  ratio  is  equal  for  all   factors     o Equalizing  factor  ratios  places  form  on  TC  curve   • MP /PF= F  ΔTC   • Measures  additional  output  per  dollar  obtained  from  additional  units  of  the   labor     • visualize  L 1  and  2  Page  261  (2)     •  Ratios  tend  to  equalize  due  to  Law  of  Diminishing  Returns     • Firm  should  always  substitute  towards  the  factor  with  the  higher  output  per   dollar  on  the  margin   Difference  in  Production  Techniques  Throughout  the  World     • India  (labor-­‐intensive)  versus  United  States  (capital-­‐intensive)     • Prices  of  capital  and  labor  are  very  different  in  the  two  countries     o India  –  price  of  capital  high,  price  of  labor  low   • P K  >  PK    P L  <  L   I I I I • Therefore  MP /P K < KMP /P US L   • Indian  manufacturer  should  substitute  labor  for  capital  until  two  ratios  are  equal   The  Incentive  to  Pollute     • Water  is  a  valuable  factor  of  production     • Firms  have  powerful  economic  incentive  to  use  and  pollute  water       •  Ideal  tax  policy?  –  set  tax  rate  equal  to  aggregate  damage  to  all  third  parties   from  the  last  unit  of  pollution  at  each  firm       Command-­‐and-­‐control  Approach     • Each  firm  receives  a  set  of  permits  that  indicate  how  much  pollution  can  be   discharged  from  each  source     • Incentives  to  break  the  law     • Marketable  permits  -­‐  -­‐___  and  trade?                 Tsuruta  8   Chapter  13    -­‐  17     Classification  of  Product  Markets   • Perfect  competition:  most  competitive  market  structure  in  which  price  sand   quantities  are  determined  by  Laws  of  Supply  and  Demand     • Pure  monopoly:  least  competitive  market  structure  in  which  a  single  firm   comprises  the  entire  industry  and  has  complete  control  over  all  supply   decisions     • Effectively  competitive:  if  individual  firms  have  very  little  control  over  price   and  other  market  outcomes     o Monopolistic  Competition:  a  product  market  characterized  by  a  large   number  of  firms  producing  slightly  differentiated  products,  with   easy  entry  and  exit,  and  in  which  strategic  behavior  is  unimportant   (i.e.  grocery  stores,  restaurants,  clothing  stores)  closer  to  perfect   competition  than  monopoly  bc  of  3  characteristics       • Noncompetitive:  individual  firms  have  considerable  control  over  price  and   other  market  outcomes.     o Oligopoly  (national):  a  market  dominated  by  a  few  large  firms   (transportation,  public  utilities,  heavy  manufacturing)     o CR4:  percentage  of  total  domestic  sales  accounted  for  by  the  four  largest   firms  in  the  industry   • Product  Differentiation:  a  situation  in  which  buyers  distinguish  or  identify   products  by  the  firms  that  produce  them;  also  refers  to  firm’s  attempts  to   distinguish  their  products  from  similar  products  produced  by  other  firms  in  the   industry     • Strategic  Behavior:  any  decision  by  a  firm  that  considers  how  other  firms  will   react  to  the  division     • Barrier  to  entry  or  exit:  anything  that  restricts  or  prevents  the  free  flow  of   resources  into  or  out  of  an  industry     Chapter  13    help  visualize  page  313     Characteristics  of  a  Perfectly  Competitive  Market   1. Very  large  number  of  firms   2. Firms  produce  identical  products  –  no  product  differentiation   3. Consumers  and  firms  have  correct  information  about  all  relevant  aspects  of   market  such  as  prices  charged  by  each  firm   4. No  barriers  to  entry  or  exit  of  firms  in  long  run  –  resources  are  free  to  move  into   or  out  of  market  in  response  to  profits  and  losses   5. Firms  cannot  behave  strategically     • Perfectly  competitive  firms  are  price  takers     • A  firm  continues  to  produce  only  if  total  revenue  is  at  least  as  large  as  the  variable   cost  of  production     • Firm’s  fixed  cost  sets  a  limit  on  the  amount  of  loss  it  is  willing  to  sustain     • Shutdown  point:  when  total  revenue  JUST  equals  variable  cost     • Break-­‐even  point:  a  market  situation  in  which  a  firm’s  TR  =  LRTC,  so  that   economic  profit  is  0.  Price  =  Long  Run  Average  Cost     o A  firm  is  breaking  even  if  the  total  revenue  is  sufficient  to  pay  all  the     Tsuruta  9   firm’s  operating  expenses  with  enough  left  over  to  provide  the  owners  a   return  on  their  capital  equal  to  the  return  available  from  the  next  best   investment  alternatives  –that’s  why  firms  are  indifferent  about  0  profit     • If  TR  >  VC,  firms  should  continue  business  because  shutting  down  would  mean   losing  FC     Accounting   • TR:  operating  expenses  –  accounting  profit/actual  returns  to  accounting  profit       Various  Average  Cost  Curves     • Average  Fixed  Cost:  at  every  output,  the  firm’s  fixed  cost  divided  by  its  output     • Average  Cost:  at  every  output,  the  firm’s  total  cost  divided  by  its  output  –  U   shaped     • Average  Variable  Cost:  portion  of  total  cost  that  changes  as  output  increases  or   decreases    (average  of)     • Marginal  Cost:  declines  over  range  of  output  where  TC  is  bowed  inward  and   increases  over  range  of  output  where  TC  curve  is  bowed  outward  –  surpasses   through  minimum  point  of  both  the  AVC  and  the srC  curves   o For  an  average  to  increase,  the  margin  must  be  above  the  average  pulling   it  up   o Margin  must  exceed  average  to  pull  it  up/margin  must  be  below  average   to  pull  it  down     Short-­‐Run  Equilibrium     • Price  =  MC   • Profit:  TR  –  TC   • TR  = e *    q   • TC  =  ATC*    q  =  (*RTC/q) q  =  SRTC  Page  320     • Profit  = e  *e q sr * e    q   1. If  Pe  > srC  then  firm  makes  profit   2. If    P  <  AC  then  firm  incurs  a  loss   e sr 3. If  Pe  = srC  then  firm  just  breaks  even     • At  market  level,  demand  starts  to  drop  to  breakeven  –  to  losses  –  to  shutdown     SR  to  LR     • All  factors  are  now  variable   • Entry  and  exit,  to  and  from  industry  possible  –  free  flow  of  resourc
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