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Chapter 4 - Elasticity

Price elasticity of demand: percentage change in quantity from a 1 percent change in price% change in Q / % change in P

ed = P/Q x 1/slope

Elastic demand: price elasticity is greater than 1Inelastic demand: price elasticity is less than 1

Unit elastic: price elasticity is equal to 1

Determinants of price elasticity of demando substitution possibilitieso budget shareo time

Perfectly elastic demand: elasticity of demand is infinite, where demand curve is horizontalPerfectly inelastic demand: elasticity of demand is 0, where demand curve is vertical

Cross-price elasticity of demand: percentage by which the quantity demanded of a goodchanges in response to 1 percent change in price of a second good

Income-price elasticity of demand: percentage by which the quantity demanded of a goodchanges in response to a 1 per cent change in income

Price elasticity of supply: percentage change in supply due to a 1 per cent change in price Determinants of supply elasticity:

o Flexibility of inputso Mobility of inputso Ability to produce substitute inputso Time

Chapter 6 - Perfectly Competitive Supply: the Cost Side in the Market

Addition of multiple supply curves: add horizontally, from price to quantity Profit maximisation firm: primary goal is to maximise the difference between revenue and

cost

Perfectly competitive markets (4 conditions):o All firms sell the same standardised producto Market has many buyers and sellers, which only exchanges in small quantityo Sellers are able to leave and enter the market as they likeo Buyers and sellers are well informed

Short run: when at least one of the factors of production are fixedLong run: when all firm's factors of production are variable

Fixed factors of production: input whose quantity does not change as output changesVariable factors of production: input whose quantity changes as output changes

Law of diminishing returns: In the short run, successive increases in input of variable factoreventually yield smaller output

Condition for short-run shutdown: firm should shut down if price is lower than the minimumvalue AVC

If P x Q is less than VC for every level of Q

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MC curve is upwards sloping due to diminishing return, and cuts the AVC and ATC atminimum points

Chapter 7 - Efficiency and exchange

Pareto efficient: no opportunity for exchange that will make one person better offany further trade will harm someone

Deadweight loss: reduction in total economic surplus that arises when market operate atprice and output other than the one at marginal benefit equals costs

Review the graphs

Chapter 9 - Quest for Profit and the Invisible Hand

Explicit Cost: the opportunity costs of resources supplied outside the firm, calculated as theactual payment to its factors of production

Implicit cost: the opportunity costs of the next best alternative when it uses resourcessupplied by owner

Economic profit: the difference between revenue and the sum of explicit and implicit costsEconomic loss: when economic profit is less than 0

Accounting profit: the difference between revenue and the explicit costs Normal profit: (Implicit costs) the level of accounting profit when economic profit is zero and

is equal to the opportunity cost of the resources supplied to a business by its owners

When new firms enter markets with economic profits, output increases as shown by therightward shift in supply curve, reducing price and profit.

When existing firms leave markets with economic loss, causes leftwards shift in supply curve,which increase price and profits

Rationing function of price: distribute scarce resources to those who place highest value Allocative function of price: to direct resources away from overcrowded to underserved

markets

Invisible hand theory: actions of self-interested, independent buyers and sellers will result insocially optimal allocation of resources

Economic Rent: part of payment for factor of production that exceeds the owner'sreservation price

Present value: amount of money we would need to invest today at a given interest rate inorder to generate a given amount of money at a specified date in the future

= M/(1+r)^t

Efficient markets hypothesis: theory that the current price of shares in company reflects allrelevant information about its current and future earnings prospects

'No Cash On The Table': if someone owns a valuable resource, the market price of theresource reflect its economic value

Chapter 10 - Monopoly and other forms of Imperfect Competition

Imperfectly competitive market: when firms have some power over price

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Pure monopoly: a market where a single firm produces all the output and there are no closesubstitutes

Natural monopoly: a monopoly resulting from economies of scale

Oligopoly: a market where a few rival firms produces products of close substitutes Monopolistic competition: a market where large number of firms produces close substitute

goods

Market power: ability for a firm to influence the demand & supply of goods, as well as price Barriers to entry include:

o Exclusive control over inputso Government-created monopolieso Economies of scale

Average total cost of production decreases as output rises [ATC=F/Q+M]Total cost of production increase as output increases [TC=F+MQ]

Profit maximisation for price setters: marginal benefit is marginal revenueProfit is maximised when marginal revenue equal marginal cost

Profit is only earned if the price is greater than the ATC

Price discrimination: charging different prices for the same product. Perfectly discriminating firm: charging each buyer their exact reservation price for each unit Group pricing: form of price discrimination where different discounts are offered in different

submarket

Perfect hurdle: an obstacles that completely segregates buyer whose reservation prices isabove it from those below it

Hurdle method of price discrimination: when a seller offers a discount for buyers who

overcome an obstacle

REVIEW THE EXAMPLES

Chapter 11 - Thinking Strategically

Basic elements of a game: (i) the players (ii) strategies available (iii) the playoffs Dominant strategy: a strategy that gives the player the highest playoff, independent of the

other player's strategy

Dominated strategy: any other strategies other than the dominant strategy

Nash equilibrium: a point where no player has an incentive to deviate from their dominantstrategy

Prisoner's dilemma: a game where each player plays their dominant strategy and theresulting playoff is smaller than if their dominated strategy was played. for e.g. game to

confess or remain silent

Repeated prisoner's dilemma: same game is played out with outcome observed from

previous games

Tit-for-tat: cooperate on the first move and then mimic opponent's move Cartel: any group of firms that conspires and coordinate production and price prisoner's

dilemma: collusions break down as players have incentive to deviate from agreed strategy to

maximise its own profits

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Credible threat: a threat to take an action that the threatener will carry outCredible promise: a promise to take an action that the promised will carry out

Commitment problem: a situation in which people cannot achieve their goals because ofincredible threats and promises

Ultimatum game: where division of money is played. Player 1 proposes a solution and the2nd player can either reject or accept

Chapter 12 - Externalities, Common Resources and Property Rights

External cost (negative externality): the cost of an activity that falls on those who didn'tpursue the activity

External benefit (positive externality): the benefit of an activity that falls on those who didn't

pursue the activity

When externalities are present, individuals will pursue in self interest, which will not resultin goods being produced at socially optimal level. Therefore outcome is inefficient.

Coase Theorem: when competitive markets, at no cost, can negotiate the purchase and saleof right to perform activities that causes externality, they can always arrive at efficient

solutions to problems caused by externalities. For e.g. toxin in river example: one party can

offer payments in return for a favour, tax & subsidies

Market based instruments: policies that use a range of approaches to positively influencethe behaviour of people to achieve targeted outcome

Quantity market-based instruments: (cap and trade) carbon permits Optimal level of pollution: when MB curve intersects MC curve. Indicates socially optimal

level of pollution

The problem of unused resources For e.g. number of cows sent onto a common grazing area.Socially optimal number of cows in relation to marginal income

Common resources: resources that are difficult to exclude people and are rival Tragedy of the commons: tendency of consumption of common resources until marginal

benefit is 0

Introduce private ownership to overcome this issue

Open access: when there is no restriction or regulation on a resource, exploitation is basedon first-come first serve

Common property: type of property rights regime where resources are controlled bycommunity of users, where rules are enforced locally

State property: type of property regime where resources are controlled by the governmentand regulatory controls are centralised

Positional externality: when a change in one person's performance changes the expectedreward of another in situations in which depends on relative performance. For e.g.

completing master's degree to make employment easier

Positional arms race: a series of mutually offsetting investments in performanceenhancement that is stimulated by positional externality

Positional arms control agreements: an agreement in which contestants attempt to apositional arm race

Chapter 13 - Public Goods and their Financing

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Rivalry: the extent to which consumption of a good or service by one person diminishes theavailability to others

Excludability: the extent to which a good or service is excluded to non-payers 4 types of goods:

o Public goods: non-rival & non-excludable - e.g. national defence, parkso Private goods: rival & excludable - e.g. cars, cheeseburgero Collective goods: non-rival & excludable - e.g. pay-TV, toll roado Common goods: rival & non-excludable - e.g. fish in the sea, the atmosphere

Free-rider problem: an incentive to not contribute to the provision of the good whenindividuals can still consume the good without contributing to the cost

If marginal cost of producing a certain good is 0, then it would be inefficient to charge theusers of the good

Advantage of government-produced public goods is once a tax collection agency isestablished, it can be expanded at relatively low costs to finance other goods

Advantage is government has the power to tax and can assign responsibility for recoveringthe cost

Disadvantage of exclusive government-produced public goods is the tax system makestaxpayers pay for good they don't want

Private provision of public goods:o Funding by donationo Development of new means to exclude non-payerso Private contracting

The benefit of an addition unit of a private good is the highest sum that any individuals arewilling to pay

The benefit of an addition unit of a public good is the sum of the reservation price of all

people

Regressive tax: tax decreases in proportion as income increasesprogressive tax: tax increases in proportion as income increases

proportional tax: pay the same percentage of income in tax

Taxes on inelastic activities may generate small deadweight loss, while taxes on negativeexternalities may increase economic efficiency

Pork barrelling: enacting legislation whose total costs exceed total benefit, but is favouredbecause their benefits from the expenditure by more than their share of the resulting extra

taxes

Logrolling: practise whereby legislators support one another's legislative proposals Rent seeking: socially unproductive efforts of people or firms to win a prize Crowding out: when government borrow funds from the private sector, causing increased

interest rates

Chapter 14: The Economics of Information

Middlemen: intermediary in a transaction of information Expected value of gamble: the average outcome if the game is played infinitely.

Calculated as the sum of the product of outcome and their respective probability Fair gamble: where expected value is zero

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Better-than-fair gamble: where expected value is greater zero Risk-neutral person: someone who accepts the gamble if it is fair or better Risk-adverse person: someone who rejects all gamble Asymmetrical information: where people on opposite sides in an exchange are not equally

informed

The Lemons Model: George Akerlof's explanation of how asymmetric information about thecharacteristics of goods tend to reduce the average quality of used goods offered for sale

Principle-Agent problem:situation when the agent's actions are costly to monitor andwhose objective is not aligned with the principal's, takes action that favours the agent

Principal: someone who hires another party to provide goods and services on their behalf

Agent: someone who is hired by a principal

Costly-to-fake principle: idea that to communicate information credibly to a potential rival,a signal must be costly or difficult to fake

Credibility problem can be overcome through warranties, mass advertisements - Statistical discrimination: making judgements about the quality of people or products, based

on the groups they belong to

Adverse selection: when people on the informed side of a market (seeking insurance) self-select in the actions they choose (to take insurance at a given price) in a way that those on

the other side are harmed

Moral hazard: tendency of people to change their behaviour once they become in a contract Disappearing political discourse: theory that people who support a position remain silent as

speaking out would create a risk of being misclassified

First dollar insurance coverage: insurance that pays all expenses associated with claimsgenerated by insured activity