Chapter 16 Summary

Chapter 16 covered markets that are oligopolies--that is, markets that fall between perfect competition and monopoly. In general, these types of markets are known as imperfectly competitive. Another example of imperfect competition is monopolistic competition, which is when many firms sell similar but different products, such as books, movies, or computer games. In an oligopoly, since there are only a few sellers, each seller greatly impacts the others' prices and profits. In these markets, firms must constantly decide between cooperation and competition. An oligopoly with 2 members is known as a duopoly, and is the simplest type of oligopoly. Firms in an oligopoly can decide to work together to set production and pricing, which is called collusion. Firms that collude in an oligopolistic market are known as a cartel and would lead to a monopoly outcome. However, cartel agreements are prohibited by anti-trust laws. If the oligopolists work independently, they will tend to produce a higher quantity and sell at a lower price, earning a lower total profit than a monopoly would. This equilibrium reached by oligopolists consider the others' actions is named a Nash equilibrium. Because oligopolists must consider the actions of all other sellers, as the number of sellers increases, the market approaches perfect competition. Game theory, especially the prisoner's dilemma, can help explain and predict the behavior of firms in an oligopoly market and the tradeoff between competition and cooperation these firms face.

Chapter 15 Summary

Chapter 15 talks about the behavior of firms that are monopolies, which refers to a situation in which 1 firm represents the entire market supply, and there are no close substitutes for that firm's product. Monopolies arise because of barriers to entry--that is, because there is something preventing other firms from entering the market. These can take the form of one firm controlling a key resource (as occurred with the DeBeers diamond monopoly), a monopoly created by the government (as occurs when the government issues patents), or a natural monopoly (when it is cheaper for 1 firm to supply the market than 2 or more) such as water distribution. While monopoly firms want to maximize profit, they face different production decisions because as they produce more they must lower the market price to sell the additional goods. Therefore, the monopolist's marginal revenue is always less than the price of the good. This leads to 2 effects on total revenue as quantity increases: the output effect (more quantity tends to mean more revenue) and the price effect (more quantity means less price). The monopoly will still set its production at the point where marginal revenue is equal to marginal cost, but here, marginal revenue is less than price, meaning that monopolists make a positive economic profit. Because of their profit-maximizing decisions, monopolies tend to increase the price of the good and reduce the quantity supplied.

Chapter 14 Summary

Chapter 14 expanded on the concepts relating to firms' costs introduced in Chapter 13 by applying them to the decisions firms face in perfectly competitive markets. An important feature of competitive markets is that firms in them are price takers (that is, their production decisions have no impact on the market price). Additionally, perfect competition implies free entry into and exit from the market. Because these firms are price takers, their marginal revenue (or the revenue they get from producing an additional unit of output) is equal to the market price. These firms maximize their profit when the marginal revenue is equal to the marginal cost. In essence, this works because the marginal cost curve is the firm's supply curve. If the firm's revenue in the short run is less than its variable costs, the firm will shut down (i.e. temporarily stop producing), treating its fixed costs as sunk costs (as they cannot be changed in the short run). In the long run, a firm will exit the market if its average total costs are greater than its revenue. When marginal cost is above average total cost when marginal cost is equal to marginal revenue, the firm makes an economic profit. However, this will incentivize other firms to enter the market, thereby increasing supply and reducing the price. Eventually, a competitive market equilibrium will arise with each firm operating at its efficient scale.

Chapter 13 Summary

Chapter 13 examined the various costs that firms face and how those costs relate to each other. The first concept introduced in the chapter was that of fixed costs vs. variable costs. Fixed costs are those costs such as office space that do not vary with the quantity of goods produced. Variable costs are those costs that depend on the quantity produced, such as labor and physical inputs. Costs can be explicit, which means they are strictly monetary, or implicit, which implies that they are not monetary and include things such as opportunity cost. Accounting profit is total revenue minus explicit costs; however, economic profit, which accounts for opportunity costs, is in general more important to firms' decisions. Fixed costs divided by the quantity produced is average fixed cost, and, since fixed costs don't depend on quantity produced, are always decreasing. Average variable costs tend to increase because of diminishing marginal product, which is the idea that as you produce more, you eventually become less efficient. Average total cost is the sum of average fixed cost plus average variable cost, and when it is equal to marginal cost (the cost of producing 1 more unit of the good), a firm is at the efficient scale.

Article Review 4

The International Monetary Fund (IMF) is hosting its yearly meetings in the next week and they are likely to focus on issues of emerging economies, which reflects a movement away from focusing on the response of developed countries to the financial crisis. Emerging economies are now exhibiting a majority of the signs of impending financial crises, including a slowdown in economic growth and, more importantly, hidden debts. By their very nature these are difficult to detect and deal with until they pile up and lead to disaster, as was seen in the 1994-1995 peso crisis that resulted from Mexico's central bank's off-books borrowing. There are several other examples where the magnitudes of various countries' currency crises have been obscured by various monetary tricks of their central banks. It is difficult to expose the current hidden-debts before they balloon into crises, especially given the lack of transparency associated with China and its financial dealings. China has long financed infrastructure projects in other developing countries. Because Chinese development banks tend not to report their lending to the Bank for International Settlements, it is likely that many countries owe far more to China than has been reported. If the debts of developing countries are understated, the decline in capital inflows (and, in some cases, capital outflows) that have occurred recently become even more significant and may cause a real crisis.

Chapter 11 Summary

Chapter 11 deals with a completely new idea: that of goods that one does not pay for using--that is, public goods and common resources. It introduces 2 major ideas: excludability and rivalry in consumption. Excludability refers to whether or not someone can be prevented from using a good, and rivalry in consumption refers to whether or not one person's use of a good decreases another person's potential benefit from that good. This allows for goods to be divided into 4 categories: private (excludable and rival), such as ice cream cones; public (non-excludable and non-rival), such as national defense; common resources (non-excludable and rival), such as fish in the ocean; and goods characterized by natural monopolies (excludable and non-rival), such as fire protection in a small town. Public goods, such as fireworks displays, can be beneficial and efficient to do; however, because of free riders (people who see the fireworks but don't pay) it is impossible for a private firm to profit from providing the good. Free riders are essentially a positive externality, and the government can subsidize a show. Examples of public goods include national defense, basic research, anti-poverty programs, and others. However, it can be difficult to determine whether the cost or benefit of these goods is greater and therefore whether it is efficient to produce them, since there is no market to regulate prices. Therefore, the government has to do cost-benefit analyses. Common resources, because they are non-excludable but rival, suffer from the tragedy of the commons: without regulation, they will be overused. This is because of the negative externality created on other users by each user of the resource.

Chapter 10 Summary

Chapter 10 introduced the first type of market failure (that is, when a market doesn’t allocate resources efficiently) discussed in detail. This market failure is known as an externality and describes a situation in which the transaction that takes place in a market has some influence on a bystander (i.e. someone who is NOT the buyer or seller) that is not considered in the price of the transaction. If this harms the bystander, it is a negative externality; if it helps them, it is a positive externality. Examples of externalities include pollution—because it harms everyone, but the producers (or consumers) of goods or services that pollute don’t pay for this harm or consider it in their costs, too many polluting activities take place. The government, through methods such as emissions limits or a tax, can help to rectify this inefficiency. By adding the cost of pollution to the supply, we can see that the true cost of a polluting good is higher than the cost to the firm, and therefore the optimum quantity is lower and the optimum price is higher. Technological spillover is a positive externality and can be represented by shifting the supply curve down: the cost to the public is less than the cost to the firm. The government should tax goods that have a negative externality to reduce the size of the market and cover the public cost of the good, while the government should subsidize goods that have a positive externality.