Buss1040 Exam Notes:

 Economics is the study of choice under scarcity – are resources are limited but our
wants are unlimited
 Key eco questions: what to produce, how to produce, how to distribute production
 Opportunity cost is the value of the next best forgone alternative – incurs both
explicit (direct payments) and implicit costs (opportunities) does not include sunk
costs.
 Marginal benefit is the benefit accrued through the consumption of an extra unit
 Marginal cost is the additional cost of producing an extra unit.
 Ceteris paribus is all other things equal
 Correlation does not equal causation.
 Trade makes individuals better off because it helps allocate goods to those who
value them the most. For trade to occur, price must be above the seller valuation
and below the buyer valuation: Vs=<P=<Vb
 Trade increases variety and volume of goods to choose from, and increases
allocative efficiency, leads to specialisation.
 A country’s production possibility frontier traces out the combinations of two goods,
x and y, that can be produced if all resources are used given current resources and
state of tech
 Labour productivity/improvement in tech can
shift PPF outwards
 At the beginning of the PPD, the most efficient
resources are used from the products,
therefore, opportunity cost increases as more
of X is produced. This is indicated by the more
negative slope.
 The slope is the opportunity cost of producing
an additional unit
 As more y is produced, the opp cost of y
increases
 Absolute advantage refers to when a country
can produce a greater number of goods than
another country
 Comparative advantage is when a country can produce a good at a lower
opportunity cost than another country
 Trading allows individuals to produce outside their PPF/total output; lower opp cost
means comparative advantage
 Short run, at least one factor of production is fixed; in the long run all factors are
variable.
 A production function shows the relationship between quantity of inputs used and
the maximum quantity of output, given tech
 Marginal production refers to how output responds when there is an increase in the
number of input. This is found by differentiating Q with respect
to L.
 If MP’ is positive, we hav increasing marginal product
 Diminishing marginal product is common due to short run
 capacity constraints – it is a short-run concept.
 Returns to scale refers to how the quantity of output changes where there is a
proportional change to all inputs. If it is the same, constant returns to scale. If more
output compared to inputs, increasing returns to scale. If output increases by less
than the proportional increase in all inputs, decreasing returns to scale. It is a long
run concept
 A cost function is an equation that links the
quantity of output with its associated
production cost
 When output is zero, total cost is positive 
fixed costs must be paid
 Total cost curve rises with output, more variable
inputs used, diminishing marginal product
 Fixed costs do not vary with quantity produced;
When TC=0, FC = 0.
 TC = VC+FC.
 Marginal cost is the increase in total cost that
arises from an extra unit of production; to find
this, differentiate TC.
 Total cots will be increasing over time due to diminishing marginal production
therefore, diminishing MP implies raising MC
 AFC = FC/q, AVC = VC/q, ATC = TC/q.
 Long run marginal costs will be less
than or equal to short-run marginal
costs due to extra flexibility in relation
to inputs etc. capital may make
variable costs go down.
 Economies of scale refers to cost
advantages that a firm obtains from
increasing its output. If long-run
average costs are increasing with
output, this is diseconomies of scale
 Assumptions: price is constant, no
changes in state of tech.

 TR = P x Q.
 Economic profit (pi symbol) = TR-TC.
 Zero economic profit means revenue
just covers opportunity cost.
 Accounting profits do not include
implicit costs. Economics do.
 Firm supply is defined as the quantity
of output a firm is willing and able to
supply at a certain price.
 A firm will sell up until P=MC. (logic it out)
  Marginal revenue for each unit that a firm
sells is the price; therefore, if P>MC, profit
up
 A change in quantity supplied refers to
movements along the market supply curve,
whereas the term change in supply refers to
a shift in the supply curve itself.
 Benefit is measured by a consumer’s
willingness to pay – what the consumer
values in monetary terms
 Total benefit is utility gained from
consuming total units, and marginal benefit
is how much benefit derived from an extra
unit.
 Diminishing marginal benefit usually exists.
 Consumers will buy the good up until P=MB.
 Market demand curve is the horizontal
summation of the total demand curves
 Markets will naturally lean towards
equilibrium  explain why
 Comparative static analysis (CSA) involves an
examination of how the market equilibrium
is affected by a change or event, a
comparison in old and new equilibrium.
 Consumer surplus is the welfare consumers receive from buying units of a good or
service in a market. It is calculated by a consumer’s willingness to pay, minus the
price actually paid for each good. This is because individual demand curve traces out
a consumer’s marginal benefit or willingness to pay.

Consumer surplus is the marginal benefit, minus the price paid, for each unit consumed.
Producer surplus: the difference between the price received by a firm and the marginal cost
it takes to produce.

 Increases when price goes down as the difference between marginal benefit and
price is now larger.
 Producer surplus is the welfare that producers receive from selling units of a good or
service
in the
market.
This is
 calculated by price minus the cost of production (as a firm’s supply curve is given by
its MC curve), so its price P-MC.
 If price raises, PS increases; the difference between price and marginal cost is higher,
they are also now selling more, so greater net benefit.
 Total surplus: TS = CS+PS
 An outcome is pareto efficient if it is not possible to make someone better off
without making anyone worse off. Competitive markets are pareto efficiency, and
therefore, pareto efficiency maximises total surplus. An outcome is not pareto
efficiency if it is possible to reallocate
resources and make someone better
off without making someone worse off
 For all the trades up to a competitive
market, MB>=MC. Hence, the
consumer is willing to pay more than
the extra cost required to make the
item. Thus, trading all units up until Q* increases total surplus (as it raises CS, PS, or
both).
 If fewer than Q units traded, it is not pareto efficient as it is possible to increase the
number of units traded in order to make the consumer/or the producer better off
 If more than Q units are traded, than MC>MB, so all untis traded beyond Q makes
someone worse off, either they paid more than there MC, or the seller received a
price less than MC, or both
 In a competitive market, the price mechanism ensures that the people with the
highest value for the product (those that are willing to pay more than the price) end
up with the goods, and those firms with the lowest costs are the ones who make the
goods, therefore, maximising total surplus.
 Elasticity measures how responsive one variable (y) to a change in another variable
(x)
 The point elasticity method is used for calculating elasticity at a single point, while
midpoint (arc) method is appropriate for calculating elasticity moving from one point
to another.
 The initial point elasticity is just the change in quantity over the change in price.(q2-
q1/p2-p1)

Need to make Q the subject for elasticity  because we are finding the change in quantity
with respect to price.
The point method can be used for determining elasticity at one point Y IS QUANTITY X IS
PRICE.
Midpoint (or arc) method:
The elasicity of demand measures how sensitive the quantity demanded of a good (Qd) is to
changes in price (P)
Given the law of demand, the elasticity of demand will be negative.
If elasticity = 0, demand is perfectly
inelastic
If elasticity -1<e<0, demand is inelastic
If elascicity = -1, unit elastic.
If elasticity <-1, demand is elastic
If elasticity = -infinity, demand is perfectly elastic.

Hence, on the elastic part of the

demand curve, price needs to be
lowered to raise TR. On the
inelastic part of the demand curve,
price needs to be raised to
increase TR. Hence, TR is
maximised and tends to move
towards being unit elastic.

 Elasticity of supply
measures how sensitive
the quantity supplied of a
good (Q) is to changes in
price (P). The elasticity of
supply is typically positive
due to law of supply
If elasticity = 0, supply is
perfectly inelastic
If 0<e<1, supply is inelastic
If e=1, supply is unit elastic (quantity supplied is proportional to price)
If e>1, supply is elastic
If elasticity = -infinity, supply is perfectly elastic.
  Cross-price elasticity measures how sensitive demand of good A is to changes in the
price of good B.
If elasticity >0, they are substitutes. (because this means an
increase in the price of good b leads to higher quantity
demand for good A)
If elasticity<0, an increase in price is associated with a fall in
quantity, therefore, they are complements
If e=0 they are independent goods (unrelated to each other)

Income elasticity measures how sensitive

quantity demanded of a good is to changes
in income.
If n<0, demand for a good decreases when
income rises. This type of good is called an
inferior good
If n=0, the demand for a good doesn’t change when income rises; a neutral good
If 0<n<=1, when income rises by 1% demand for the good increases by less than 1%. This
good is called a normal good.
If n>1, when income rises by 1%, demand for a good increases by more than 1%. This is
known as a luxury good.

In general, elasticity tends to be greater in the long run than the short run, as people have
time to adapt to the new change

 Perfectly competitive markets have many buyers and sellers, low barriers to entry,
no product differentiation, and firms have no market power to set prices.
 Monopoly markets only have one seller and high barriers (near impossible) barriers
to entry, only one product, and seller sets the price
 Monopolitic competitive markets have many firms with some product
differentiation, low barriers to entry, and a small capacity to set prices
 Oligopoly markets have high barriers to entry, some product differentiation, and
price setting power.

Perfectly competitive markets:

 Short run: each firms plant size is given, fixed inputs (eg. Capital goods), number of
firms in the industry are fixed
 Long run: plant size can change as all inputs are varied, and firms can enter and exit
the industry
Fixed cost is sunk cost. Therefore, deciding what to produce in the short run, only variable
costs will be considered.
 The shut-down condition in the short run is
when total revenue is less than variable costs:
TR<VC< or, P<AVC (min). This is because firms
will continue to produce to minimise fixed cost
losses (and hence, it is not ATC).
 In the short run, the supply curve is derived by horizontally summing the individual
supply curves (the MC curves above AVC(MIN)
 To make profit, TR>TC, or if you divide by q, p>ATC.
 The difference between the price and the ATC, multiplied by the quantity supplied,
represents the firms profit or loss.
 In the long run, there is free entry and exit
into the market because all inputs are
variable, and a firm wishing to exit the
market is not hindered by having to pay
fixed costs. This means all costs are
opportunity costs.

 therefore, the exit/entry decision is

P<ATC(min)

 A firms long-run marginal cost curve may

not be the same as its short-run marginal
cost curve
 Firms will enter/exit the market when it is
profitable to do so; this leads to an
equilibrium where there are no profits or
losses in the market in the long run.
 When firms are profitable, more firms
enter, shifting supply curve to the right,
price goes down, profit gone.
 As prices will adjust back to
ATC(min), long term supply is
perfectly elastic at P=ATC(min). An
industry with a perfectly elastic long-
run supply curve is a constant cost
industry.
 A totally competitive industry
maximises the level of total surplus.
 This assumes the costs and the level
of technology are the same. And it
doesn’t account for if potential
entrants have higher costs than incumbent firms.
 Some industries have an upward sloping long-run curve (an increasing-cost industry).
Following an increase in demand, entry of new firms will continue to occur until the
next potential entrant doesn’t anticipate making a profit. In an increasing cost
industry, firms with lower production costs can earn positive eco profits. Eg.
Airports.
 Other industries are decreasing cost industries; this would occur as output if an
industry expands, costs for all firms fall. Eg. Software. In this industry, as demand
increases, market output will expand and average costs could fall. As such, following
an increase in demand, entry will continue until it is no longer profitable, and the
new long-run equilibrium price is below the one from before.
In perfect competition, the demand curve for a firm is horizontal at the market price
(because it’s the same product they would just go elsewhere)
In the LR, a competitive market equilibrium earns zero economic profits. Hence, profits will
neither increase, or decrease. LR equilibrium price will fall, which implies an increase in the
quantity traded in the market, however, more firms will be operating in the market.

 Markets with one seller are a monopoly, while the seller is a monopolist eg. Sydney
water
 Characteristics:
One seller and many buyers: one producer
Price market: because the monopolist is the only firm in the market, it has the market
power to determine price
Barriers to entry
Sometimes a natural monopoly is more efficiency.

 A firm with lower price elasticity, a more inelastic curve, can raise price and not lose
its customers. As a monopoly has market power, the monopolists price will be its
profit maximising choice.
 Price discrimination is the practice of selling different units of a good or service at
different prices.

Marginal revenue is the additional revenue that a firm receives from selling one extra unit of
a good. Because a monopolist faces a downward sloping demand curve, if it increases
output by one unit, price will fall by the same amount. Hence, two effects;
 Output effect: as you sell more units, you obtain
extra revenue from the additional units sold, and
 Price effect; as you sell more units, price falls
and you lose revenue.
 For a monopolist, MR is less than price (MR=P
for competitive)
 To find marginal revenue, differentiate total
revenue with respect to Q. Or just double the
gradient part of the demand curve.
Hence, profit will be maximised when Marginal revenue
= marginal cost
Profit=TR-TC. Differentiate, and you get MR-
MC=O. therefore, it’s a max at MR=MC.
Therefore, MR>MC, raise production. MC<MR,
reduce it. This means for a single price
monopoly, P>MC.
Profit is TR-TC, whereby PxQ-ATCxq = (P-ATC)xQ.

A firm will not supply MR<0 because this means

that MC>MR. Producing less here simply means
profits will decrease.
Socially efficient level of output is where
MB=MC, but, monopolists produce where
MR=MC.

Consumer surplus is below the demand curve

Producer surplus is above the MC curve

The area of total surplus is smaller than

a competitive market because quantity
traded is lower. This results in
deadweight loss (DWL).
Thus a monopoly is inefficient as it does
not maximise total surplus. It converts
consumer surplus into producer surplus,
and generate DWL. This is because the
monopolist restricts its output below
the efficient quantity (Qm<Q*) as there
are consumers in the market with a
higher MC than the MC of producing
extra units of production.

For a monopoly, P<MC, and P>MR.

The idea behind price discrimination is to
bring back consumers into the market by
charging them a lower price, while still
charging a higher price to customers with a
high willingness to pay. It can therefore
raise profits.
In order to do this, the firm needs market
power to determine prices, and it must
prevent arbitrage, that is, preventing
consumers who are charged a lower prie
from selling the product to a consumer
with a higher willingness to pay. To do this, the firm will need information about different
customers and their willingness to pay for the product.

 First degree price discrimination (perfect price discrimination) is when a firm

charges each consumer his or her exact willingness to pay (Marginal benefit) for
each unit consumed. Hence, the monopolist gains all consumer surplus, and receives
all the gains from trade in every transcation.
However, they need to know perfect information
about the consumer, and prevent arbitrage.
No DWL as they capture all surplus.
They will cotninue to sell up until MB=MC.
Another way this occurs is through a two-part
tariff, whereby the monopolist charges the
consumer two distinct fees – a fixed fee of F that
does not change with the number of units
consumed, and a per-unit fee of P, for each unit
consumed.

 eg. A fixed part of the

product (core product
like a printer) and a
non-durable (ink
cartridges)
 The monopolist sets
MB=MC

As tye MC for the last unit sold equals to MB, the quantity sold by a perfectly price
discriminating monopoly is efficient.
 The monopolist charges a fixed fee each to consumer’s total surplus. The per unit fee
is equal to MC.

Third-degree price discrimination: this occurs when the firm seperates consumers into
markets, and charges a different price for each market. Eg. Different prics for haircuts
between men and women
 The information and arbitrage requirements for third-degree price discrimination are
less stringent than for first-degree.
 They can’t prevent arbitrage between groups however.
  The monopolist doe not need to know each individuals demand curve, only the
markets
 Under third-degree price discrimination, the firm essentially acts as a single price
monopolist; it just faces a different demand/marginal revenue curve. Therefore,
assuming that a monopolist faces a constant marginal cost, it solves the profit
maximising price/quantity in each market
 For profit to be maximised, marginal revenues need to be equated across markets.
They produce where MR=MC. As MRs are equal across different markets with third
degree price discrimination, prices can differ between two markets. You can charge
a higher price in a more inelastic
market.

 Second degree price discrimination

occurs when a monopolist knows
there are different types of
consumers in terms of their WTP,
but it does not know the type of
any particular indiivudal consumer.
In third, they know the type of
customer, in second, they know hat
type of consumer they could be.
Because the monopolist cannot identify which type any particular consumer is, it needs to
offer different versions of the product (at different prices) so consumers ‘self-select’ and
reveal the type of product versions they choose. Eg. Airline tickets
Second degree price discrimination has lower information and arbitrage requirements than
the other two types – all they need to know if there are different types of consumers in the
market.
It assumes the cost of production is zero
Buyers only purchase one unit
The consumer chooses the version that gives them the highest consumer surplus
Essentially, consumers are self-selecting

 Price discrimination will never decrease profits – only raise.

 The ability to price discriminate depends upon a firm’s ability to present arbitrage
and the information they have about consumers.
 Firms can do multiple types of price discrimination

A natural monopoly is an industry where a single firm can supply an entire market at a cose
lower than two or more firms. This occurs in industries where there is a large fixed cost and
a relatively low marginal cost.
EG. Electricity, where the cost
of building infrastructure is
high, but the marginal cost of
delivering is low.
  Often, these have declining average total costs due to high fixed costs but relatively
less variable costs are quantity supplied increases.
 A natural monopoly arises
from the combination of
the level of demand and
state of technology.

Governments can address

natural monopolies through
government intervention;
whereby they take ownership
of the monopoly. However,
governments tend to be
inefficient.
Marginal cost price regulation
– the government can regulate
the price that a monopoly can
charge. In order to maximise
surplus, the government could mandate the monopoly charge the efficient price of
P=MC. This eliminates DWL. However, the monopoly would make a loss equal to the size
of its fixed costs, and may choose to exit the market. However, at this price, the
monopolist only covers variable costs not fixed costs. Governments need to hence
subsidise. This is politically unfavourable.

 To avoid a subsidy, the government could impose a price equal to average cost,
so that the monopolist is able to
charge a price that just covers
cost of production. However, this
quantity is less efficient and DWL
still exists. At P=ATC however, it
produces less than the efficient
quantity (the monopolist does
not produce MB=MC), so there is
still DWL. But overall, DWL is
decreased.

Governing natural monopolies is difficult, as the governments ability to improve welfare is

not guarateed. This is worsened by the fact governments have limited information about
market, costs, and tech. Monopolies likely have this information, and it is the interest of the
monopolist to convince the gov that marginal cost is high, even if MC is actually low.
Governments tend to regulate monopolies by raising competition.

Monopolistic competition:
 Many buyers and sellers
  Firms produce similar, but differentiated products
 There is freedom of entry and exit

As a result:
 No one firm can influence what the other firms do
 Firms face a downward sloping demand curve
 Firms earn zero eco profit in the long firm

Unlike monopoly, the demand curve is not the market demand curve – they all sell a
differentiated product.

SHORT RUN;
 Firms behave like monopolists. This is not a supply curve for the market; IT IS AN
INDIVIDUAL FIRMS CURVE.
Firms produce where MR=MC
They are, to some extent, price makers
Firms can each short run eco profits
Produce less than capacity – they produce at less than the output that minimises average
total cost
In the short run, the number of firms in the market are fixed; because each firm faces a
fixed cost of production, constricting the ability for firms to enter and exit the market in the
SR.

LONG RUN:

 If a new firm enters the

market, this will decrease
demand for the produce in
the market; shifting the
supply curve to the left
 The demand curve for the
product of firms in the
market will become more
elastic; if they raise prices,
 individuals are more likely to switch to an alternate product.
 The entry of firms in the market decreases demand for other firms
 Exit increases demand for other firms

When firms enter the industry, firm demand curve and

marginal revenue curve shift leftward  resulting in
more elastic/price responsiveness
The profit maximising quantity and price hence fall
Therefore, as there are zero economic profits, prices
will equal ATC in the long run
In the LR= eco profits are zero.

For these conditions to hold, MR=MC and P=ATC, ATC

is tangential to the demad curve. Note that zero profits mean that the firm is making a
positive mark-up on all units it sells, but these variable profits (revenue – variable costs of
production) only just cover the firm’s fixed costs.

Therefore, firms in a competitve market trade at P=ATC. This means that ATC>MC, so
average costs are not minimised. This means that P>MC, hence, there is DWL associated
with each firms output; as the gains from trade are not realised. Also

 Business stealing can occur: this does not lead to greater surplus, but it does mean
the economy has to bear another firm’s fixed costs of production
 Product variety: on the other hand, a firm entering the market offers additional
differentiation in the market. Product differnetiation can raise consumer surplus,
due to greater variety.
Monopolistic competition:
SR: MC=MR, P>ATC
LR: MC=MR, P=ATC.

This is because in the long run, the firm equates MR and MC. This means that P=ATC, and as
such, P>MC, so ATC is not minimised.

Perfect Competition Monopoly

A price taker Influences price (price maker)
Produce where p=mc Produces where MR=MC
P=mr=mc P>MC, P>MR
No barriers to entry Barriers to entry
No eco profits in LR Restricts output, charges a higher price
and can earn eco profit

Game Theory/Oligopolies:

Oligopolies are where:

 A small number of firms compete
 Firms may produce identical or differentiated products
 Firms have some market power
 There are barriers to entry such as economies of scale, entry or exit costs, patents,
and strong brands.

Strategic interactions between economic agents can be analysed using game theory. This is
because a small number of firms recognise that:
 Actions of rivals impact profits, and thus, firms have an incentive to act strategically
to influence the actions of competitors.
This strategic interaction explains a firm’s choice over price, quantity, advertising, market
entry.

Game Theory describes how firms interact in a strategic sense is sensitive to a particular
market situation.
A game consists of players, rules describing how the game works, strategies are contingent
on a place of action, and payoffs. It has a complete description of what action each player
may take, and a specification of each player’s payoff.

 A dominant strategy is one that is optimal for every possible strategy of your rival. A
weakly dominant strategy gives a payoff that is at least as good as any other
strategy, a strictly dominant strategy gives a strictly larger payoff for every possible
rival strategy.
 Each player acts to maximise their individual payoff, and this often produces a
collective outcome that is inefficient AND total surplus it not maximised.
 The Nash Equilibrium is the solution concept of a game for two or more players. A
NE exists if each players choice of action is their best response to every other
player’s strategy.
If each player has chosen a strategy & no player can benefit by changing their strategy while
the other player keeps there unchanged, the current set of strategies represents a NE.
No player can gain by changing strategy unilaterally – no profitable unilateral deviation.
In a nash equilibrium, each player takes their best possible action given the action of their
opponent.
 A Prisoner’s Dilemma is when each player has a dominant strategy, there is a unique
nash equilibrium, and the nash equilibrium surplus is not maximised
Firm’s can avoid prisoner’s dilemma if pre-game communication before they make their
move, or choice in which case they will promise to. However, firms lie.
 Commitment is possible if an industry group or government removing the option to
cheat by banning advertising, however, future punishments make cheating less
attractive.
EG. if a game is repeated, one firm has the opportunity to punish another.

In a sub-game perfect equilibrium, each player’s actions are a NE in every subgame.

Therefore, the only way to have a sustainable cooperative outcome is with appropriate
punishment strategies:
Tit-for-tat punishment:
 Cooperating as long as your rival cooperated yesterday
 If your rival cheated yesterday, you punish them by cheating today
 Punishment is temporary – one period only
 Threat of punishment dissuades cheating.

Trigger strategies:
 Cooperate as long as your rival cooperated yesterday
 If your rival cheats, punish them forever.
 Eg. price wars resulting from firms entering a monopoly industry.
It is possible to have 0,1,2 nash equilibriums.

Playing a game a finite number of times does not affect the outcome of the game. This is
because the penultimate time they interact, they know what will happen next; they will
both cheat. As such, they will consider cheating everytime. As such, if they play a finite
number of times, firms will continually set low prices.
  Basically, if the game is played a finite number of times, firms have no incentive to
cooperate in the last round, and therefore they have no incentive to cooperate in
the second to last round, and therefore have no incentive to cooperate at all.
Firms will only cooperate if the game is played indefinitely, and punishment is possible.

Analogies in business: eg. technology choice, positive location externalities, product

differentiation. Can get around this through ritual, routine or customs, standard setting by
gov or industry. Also, communication; is it credible?

However, players often make choices sequentially. This could happen during a bargaining
setting. In this game, there is an incumbent and a potential entrant.
There must be a subgame perfect equilibrium - each players strategy must be a NE in every
subgame.
To solve such games, backwards induction must be used.
This identifies the subgame perfect equilibrium so that every player’s action is a nash
equilibrium. This identifies a credible equilibria.
 The key is to get rid or eliminate non-credible outcomes, so we need to solve
backwards.
 At each point a decision occurs, it is called a node, eg. t=0 or t=1.

However, bargaining doesn’t always proceed with a take-it or leave-it offer.

 Often, the person who makes the last offer obtains the most surplus. Therefore, the
person who makes the last credible offer makes the most profit.
 Sometimes, there is strategic advantage by limiting choices.

First mover advantage and second mover advantages can occur -> eg. first mover
advantage gets to apply a patent on technology, while a second mover gets to ‘free ride’
investment.
Zero-sum games can occur – where every option in the cell sum to zero.
Remember  repetition can facilitate cooperation.

In single offer games, the person making the offer receives all the gains from trade.
This is because that party is the only party who can make offers, and hence has all
the bargaining power. The other party has to accept or reject the offer, but rejecting
means they receive zero surplus.
In multiple-offer bargaining, the second person usually receives all gains from trade.
This is because they get to make the last offer  this means they are able to credible
commit that this is the last chance to trade, meaning A has to accept or reject the
offer.
However, in bargaining situations, the gains from trade are usually shared by the parties,
because,
 There are costs to bargaining
 Parties don’t know when the bargaining will end
 The parties may not know each other’s valuation of the object
 Outside options
In these cases, there is a breakdown of bargaining.
One defining characteristic of a prisoner’s dilemma is that its equilibrium does not
maximise profits. Pre-game communication can be used to create maximum profits.
However, firm’s need to make binding commitments to ensure they cannot break the
commitment.
Repeated games will facilitate cooperation.

Sources of Inefficiency:

Price signals are not always consistent with price ceilings/floor/taxes/subsidies.

Public goods: goods for which one persons consumption does not detract from another’s
consumption or enjoyment for the good.

Price controls or regulations are enacted when the market price is deemed unfair. This
includes minimum wages, public housing, agricultural price support schemes.

 A price floor (pf) establishes a minimum price which a good can be sold
The floor is not binding if it is set below the equilibrium or market clearing price
It leads to a surplus if it is binding. A binding price floor creates DWL or a loss of total surplus
 some gains from trade are not realised.

 A price ceiling (PC) is a legally established maximum price at which a good can be
sold
It is not binding if it is set above the equilibrium, or market clearing price
Leads to a shortage if it is binding.
Non-price rationing means determine who get the good or service  eg. rents and housing
price controls leading to queues,
discrimination by sellers, black market.
  If a price floor is implemented, we are on the elastic part of the demand curve (as
the midpoint is unit elasticity). As the price elasticity of demand is elastic, total
revenue/expenditure will fall if there is a price increase, and consequently, total
revenue will fall due to the imposition of the price floor.
 The calculations of producer/consumer surplus assume that the lowest cost
producers supply the market. If higher cost producers supply the market, PS will be
smaller than the number calculated (and the DWL resulting from the price floor
larger).Equally, the DWL could be higher if it is not the consumers with the highest
MB buying the good.

 Typically, supply and demand will be more elastic in the long run as participants in
the market adjust to conditions. This means shortages/excesses will usually be
worsen in the long run.
If a tax is imposed, buyers pay more than the sellers receive (and keep)
If a subsidy is imposed, buyers pay less than the sellers receive (and keep)
Buyers respond to post-tax prices
Sellers respond to pre tax prices.
Taxes and subsidies are used to raise revenue, correct market failure eg. externalities, and
income support.
Two types of taxes: specific, tax per unit purchased (tax is fixed) and ad valorem or
proportional tax (tax depends on how much you purchase)

Income of the tax describes who bears

the economic burden of the tax. In
general, this falls partly on buyer and
seller, who lose surplus as a result of
the tax.
 The economic burden of tax is
distinct from the legal
requirements to pay the tax.
Legal requirement of the tax DOES NOT AFFECT economic incidence
 Imposing the tax on buyers or sellers does the same thing

A tax on suppliers shifts the supply curve up.

A tax on buyers shifts the demand curve down.
Tax incidence and elasticity:
 The more inelastic the supply, the more the seller pays
 The more elastic the supply, the more the buyer plays
 The more inelastic the demand, the more the buyer pays
 The more elastic the demand, the more the seller pays

In general, the burden of the tax falls on the more inelastic side of the market.
In a perfectly elastic supply market, the buyer bears the full economic burden paying all the
tax. If a tax was imposed on a perfectly elastic supply curve, it would move up by the
amount of the tax. Therefore, equilibrium price increases by the exact same amount of the
tax, so the buyer bears all the economic burden of the tax.
In perfectly inelastic supply, the seller pays all the tax, or bears the full economic burden. In
a perfectly inelastic market, the supply curve wouldn’t move. The supply curve is more
elastic than the demand curve,
so they bear the full eco burden
of tax.
 The economic
burden/incidence is
unaffected by who the
tax was imposed on.
If not perfectly elastic or
inelastic, the burden of tax will
be shared. You generally aren’t
allowed to determine elasticity
based on slope.

If demand is relatively inelastic

and supply is relativity elastic,
the price rises by a large about
when the tax is improved on
sellers. Thus, the economic
burden of the tax is largely borny
by buyers.
If demand is relatively elastic and supply is relatively inelastic, price rises by a small amount
when the tax is imposed. That is, the economic burden of the tax is largely borne by the
seller.

In general, the more elastic the supply

and demand are, the larger the DWL is.

In general, the DWL increases more

rapidly than the tax – doubling the size of
the tax leads to a quadrupling of the DWL.

Therefore to minimise DWL, we should

tax things with more inelastic demand, eg.
cigs, alcohol, petrol.

Subsidies are, in essence, negative taxes.

DWL exists because MC>MB for all the extra

units consumed past the efficient equilibrium.
The DWL with a tax is due to the difference between the price received by consumers, and
the price received by consumers. (the difference between the Marginal Cost, and the
Marginal Benefit).

Competitive markets are usually pareto efficient. However, there are some situations
where market outcomes will not be efficient  this is called market failure.
An externality is a cost or benefit that accrues to a person who is not directly involved in an
economic activity or transaction. This is because the market does not take into account
external costs and benefits when consuming a product.

A positive externality occurs when economic activity results in external benefit for a third
party
A negative externality occurs when economy activity results in external costs for a third
party.
 The marginal benefit to society of an additional unit of a good consumed is known
as marginal social benefit (MSB). It is made up of marginal private benefit and
marginal external benefit. MSB = MPB+MEB.

In a positive externality, the marginal social benefit > marginal private benefit, and this
difference is the size of the externality for any given unit. The increasing gap shows the
positive externality raises with increasing output.
Alternatively, a diminishing gap between MSB and
MPB would represent declining positive externality.
If no positive externality, MEB=0 and MSB=MPB.

The marginal cost to a society for addition units of a

good produced is known as marginal social cost
(MSC). It is made up of marginal private cost (MPC),
and marginal external cost (MEC), accrued by a third
party
MSC = MPC + MEC. (Marginal social cost = Marginal
Private Cost + Externality)
An increasing gap indicates the externality
increasing with output: it could be constant. MEC =
0 means MSC=MPC.
  Externalities are a source of market failure because they represent external
costs/benefits not accounted for by the market.

Positive Consumption Externality: MSB>MPB due to

external benefit. At equilibrium, there is an
underproduction because consumers and producers
have no private incentive to do so. The loss of
production is the DWL (Because from Q->Q*
MB>MC).

A negative production externality means the

MSC>MPC. Hence equilibrium has an
overpdocution. DWL is the difference between Q-
>Q*, as MC>MB for all those produced.

 Negative consumption, and positive

production, externalities also exist.
 In a negative consumption externality,
MC>MB for the difference between
MPB/MSB.
 For a positive consumption externality,
MB>MC for the difference between MPC and MSC.

Solutions to externalities:

Coase theorem: provided property rights have been clearly assigned, and there are no
transaction costs, bargaining will lead to an efficiency (socially optimal) outcome regardless
of the initial allocation of property rights.
 Property rights refer to the right to decide whether, and to what extent, the
economy activity causing the externality goes ahead. It doesn’t not depend on how
allocated, merely how they are allocated. However this does have ramifications for
how the gains are distributed.
However, Coase theorem failures:
 Property rights not being defined: it is not always clear who has property rights
 Transaction costs: The Coase theorem assumes that there are no transaction or
bargaining costs. If the costs are too high, it could prevent trade from occurring.
 Identity of parties unknown: if the parties are unable to identify each other, it will
not be possible to engage in trade

Government solutions: taxes and subsidies

Positive externalities:
 To raise quantity traded in the market, governments grant a subsidy to increase
consumption, and hence the positive
externality.
 When the subsidy is given, the MPB
curve shifts up by the size of the
subsidy, and the subsidy should be
equal to the size of the externality.
 This causes market participants to
internalise the externality, and
implements the socially optimal
outcome. This eliminates DWL.
Negative externality:
 Lower the quantity – put a tax on it.
 When the tax is imposed on consumers, the MPB curve shifts down by the size of the
tax, decreasing the quantity
traded in the market.
 The size of the tax should be the
size of the externality (the
marginal external cost)

The government could also use quantity regulations  where the government simply
regulates the quantity in the market through licencing/permits.
 The tax is advantageous as it gives the firm financial incentive to avoid the tax;
incentive to innovate.
 Some firms reduce emissions more cheaply than other firms. A tax, by setting a price
for pollution, allows for unequal reduction of emissions across firms and industries.
This in turn reduces the cost of achieving the required reduction in emissions. A
regulation does not do this: as reducing emissions is not done in the least-cost way;
low-cost firms do too little, and firms for which reducing emissions is costly do too
much.

Trading permits:
  Trading permits are a special type of licence that may be transferred between
parties, thus, consumers or producers may trade with each other for the right to
consumer or produce output.
If a firm holds a permit, the opportunity cost is it can’t sell it
If it sells it, it can’t use the permit
The market for the permit means that, regardless as to the initial distribution of the permit,
the firm will trade the permits so that efficient outcome is achieved.
For every level of tradeable permits, there is an equivalent tax that could implement the
same outcome.

Marginal abatement cost – type 1 firms

Marginal abatement costs – type 2 firms

The blue firm, which has a lower marginal cost of

abatement sells its right to pollute, and therefore
must reduce the amount of pollution it generates
The green firm, which has a higher marginal cost of
abatement buys the right to pollute and therefore
can increase the amount of pollution.

Private goods have two characteristics:

 Rivalry in consumption
 Excludability
Pure Public Goods
 Non rivalrous – my consumption of the good (such as public broadcasting) doesn’t
detract from yours
 Non-excludable – individuals cannot be excluded from consuming it.
Free Rider Problem – those who don’t pay for them cannot be excluded from consuming
them.

We need to compare marginal social benefits, and marginal social costs, to consider how
much to provide.

 In deriving the demand curve for a

public good we want to vertically
summate the demand curves
Reflects the fact that the public good is non-
rivalrous
For any amount of the public good, we want
to identify the total willingness to pay of all
consumers, keeping in mind they can consume the same units.

In the case of a public good, this means the quantity

where the marginal cost of providing the good is
equal to society’s total MB of the good.

Common resources:
 Rivalrous in consumption: one persons consumption detracts from another
 Non-excludable – people cannot be prevented from consuming the good.
An example is water.
 Because of non-excludability individuals will tend to consume too much of the good
Individuals consume as long as the private MB>Private MC.

Tragedy of the Commons:

 Individuals choose a point where the MPB =
MPC. Usually the MPB is just the average
benefit received by the user of the
resource.
 The efficient outcome therefore
corresponds to where the MSC=MPB.
 This leads to significant over-exploitation.

Remedies:
 Grant property rights
 Make the resource excludable.

In some cases, a market may be affected by

more than one externality. In the presence
of multiple market failures, it may be preferable not to address a single market failure on its
own.
 The theory of second best posits that if there is a market failure that cannot be
corrected, actions to correct other market failures may have the effect of decreasing
total surplus.
For example, if you have two market issues of a monopoly and a negative externality,
correcting the monopoly may worsen the negative externality.

Macroeconomics:
Gross Domestic Product – GDP or nominal GDP is the monetary value of all final goods and
services produced in a country in a given time period.
 It is a final goods and services: not including things that are used in the production of
other goods or services

1. Final goods or expenditure approach:

GDP = C+I+G+X-M (National Income Accounting Identity – it is always true).
Consumption (c)
Investment (I)
Government (G)
Exports to foreigners (X)
Imports (M)

2. Production or value added approach

Often difficult to distinguish between intermediate and final goods; value added approach
alleviates this. This is calculated by Value added = Firm’s revenue – immediate inputs.

3. Income Approach
Think of GDP in terms of where payments for goods and services go:
 Compensation of employees (wages)
 Gross operating surplus of producers (Profits + depreciation + interest payments)
 Taxes on production, less subsidies (indirect taxes)
GDP = wages + interest payments + indirect taxes + depreciation + profits
GDP = wages + gross operating surplus + indirect tax

Nominal GDP is the money value of final goods and services during a given year, valued at
the prices that prevailed in the same year. Nominal GDP is just a more precise name for GDP
Real GDP is the value of final goods and services produced in a given year when valued at
the prices of a reference base year
Real GDP= Nominal GDP divided by a price index
Real GDP moves with changes in the quantity of goods and services produced, not with
changes in prices.
 You use the original prices, but use the new quantity to find real GDP.
Long term growth comes from:
 Growth in the labour force (employment)
 Growth in the skills of the labour force (human capital)
 Growth in the capital shock (investment)
 Growth in the productivity (technology)
Income depends on spending, and planned spending
depends on income.
 Planned spending and the aggregate expenditure
(AE) schedule.
 The planned aggregate expenditure (AE) schedule is
upwards sloping.
Equilibrium is where AE=Y.
Equilibrium is where planned AE interested the 45 degree
line, where AE=Y.
 At Y1, output > AE. Some goods produced go unsold:
unintended inventory accumulation. Firms reduce
output
 At Y2, planned AE> output, so firms inventories get
depleted. Firms raise output.
 If planned AE is flatter, the change in income, and
hence the multiplier, is smaller.
 More spending on imports could worsen the
multiplier, despite higher income
AE = A + bY
Where A is the vertical intercept for autonomous spending,
and b is the marginal increase in planned AE from an
additional dollar of income (Y).
If a government tax is added:
AE = G + A + b(1-t)Y. This is because
C = C(hat) + Byd.
B is the MPC (savings function = 1-b of income), whereas Yd is disposable income, which is
income less taxes. Therefore, yd = Y – Taxes = Y –T (lump size tax, doesn’t depend on income
–ty proportional tax
Yd = Y – T - tY
1/(1-b) is the expenditure multiplier.
Deficit = G-tY
A closed economy does not have X-M.

GDP at purchasing power parity:

 GDP at PPP uses international prices to measure a country’s real GDP
 GDP per capita = GDP/population. GDP per capita is highly positively correlated with
wellbeing, however they are not the same thing
GDP doesn’t consider life expectancy, health, literacy rate, education levels.

The Keynesian cross treats prices as fixed and does not address inflation – it is a short run
model (the period of time in which prices do not adjust to responses in changes in demand).
Exogenous expenditure – the portion of planned aggregate expenditure that depends on
output.
Income-expenditure multiplier – the effect of a one unit increase in exogenous expenditure
on short-run equilibrium output.
REAL GDP = Nominal GDP/ Price Index.
OUTPAT GAP: The difference between actual GDP and potential GDP.

Problems measuring output:

 Measuring quality changes is difficult
 Measuring service output  hard to determine between intermediate, and final
goods
 Measuring nonmarket goods  such as unpaid housework done by family members.

Unemployment: measure of utilisation of an economy’s labour force

 The working age population are those above the wage of 15
 The working age population is divided into the labour force (working and seeking
work) and those not in the labour force.
 The labour force is the sum of employed and unemployed workers.
To be considered employed, you must
 Work for more than 1 hour as a paid employment, or in a family business, or a farm,
and
 Had a job or business from when they are temporarily absent.
Underemployment: the underemployment rate is the proportion of the labour force that
has a job, but would like to work more hours.

To be counted as unemployment, a person must:

Be actively looking for full of part time work, and been available to work in the reference
week, or
Waiting to start a new job, and could have started if job was available.

Unemployment rate:

Labour force participation rate:

Employment to population ratio:

Frictional unemployment: short term unemployment resultant from job search: new
entrants, layoffs, people qutting
Structural unemployment: mismatch between worker’s skills and job vacancies
Frictional and structure compromise the natural rate of unemployment
Cyclical unemployment: unemployment resulting from the business cycle.

Full employment means there is no cyclical unemployment.

Potential GDP is the quantity of real GDP produced at full employment. Potential GDP
corresponds to the capacity of an economy to produce output on a sustained basis.
Real GDP – Potential GDP is the output gap.
 Over the business cycle, the output gap is closely related to fluctuations of the
unemployment rate around the natural unemployment rate.
Okun’s law: to reduce unemployment, economic growth must be greater than the increase
in labour productivity and growth in the labour force.
 A 2% increase in Real GDP growth above trend reduces the unemployment rate by
about 1%.

The price level is the average level of prices – it determines the value of money
 A persistently rising price level is inflation
 A persistently falling price level is deflation

CPI determines the basket of goods and services consumed from the household expenditure
survey.

Inflation is costly because:

Search costs: people spent more time searching for better deals
Cost of changing prices, menu costs
Erodes purchasing power
Greater risk and uncertainty; variability in prices.
Tax system distortions: bracket creep, mismeasurement of income and expenditure.
Unexpected redistribution of wealth: reduces real value of debts and real value of cash.
Therefore debtors are disadvantaged (its easier to pay off debt with higher inflation).
Deflation is worse because
 Real value of debt rises
 Debt burden increases
  Bankruptcy & Unemployment: consumers put off purchases and firms profit margins
decline
A little inflation makes it easier to reduce real wage when nominal wages are hard to
reduce.

Alternative measures of the price level are:

 GDP deflator: measures the prices of goods in
a country rather than goods consumed
 Core of underlying inflation.

Phillips curve: if unemployment is low, harder to hire

workers and easier for workers to find other jobs.
Therefore, worker bargaining power increases. This
leads to higher wages. This leads to wage growth:
cost-push inflation.

Short-run Inflation Adjustment Curve:

Wage pressures that cause increases or decreases in the inflation rate, as generated by
cyclical unemployment.
 When output is below potential, so cyclical unemployment is positive, wages rise
more slowly.
 When output is above
potential output so that
unemployment falls
beneath the natural
rate, wages rise more
quickly.
This generates a short-run
relationship between
output and inflation.
Inflationary expectations also matter: Output>potential one
year, inflation increases. Workers and firms then expect
higher inflation the next year, and negotiate wages
accordingly.

Inflation shocks shift the SRIA curve.

Recessionary gap: a negative deviation of real GDP from its

potential

Expansionary/inflationary gap: a positive deviation of real GDP from its potential.

The recognition that the SRIA curve shifts as inflationary expectations change emphasises
what when output remains above potential (the unemployment rate remains below the
natural rate of unemployment), the rate of inflation increases. When it remains below
potential (the unemployment rate is above the natural rate), inflation decreases.
 The inflation adjustment curve relates inflation to the state of the economy:
measured by a comparsion of actual output with potential output.
  Nominal Interest Rate = Real Interest Rate + Inflation.
CPI assumes fixed expenditure weights. But in reality, consumers substitute away from
items whose relative prices are increasing.
Phillips curve is the relationship between unemployment and inflation.

Week 13:

 The mainstream view is that the proximate cause of recessions are declines in
aggregate demand.
However how does a shortfall in AD occur, when expenditure SHOULD equal national
income.
When spending=income in a national account identity, it says nothing about the way in
which causation runs.
Mainstream view of the GFC:
 Household price bubble
 Large increase in household debt in GDP
 Centralised debt obligations
 Lending standards drop. Mortgage delinquencies increases, especially for low quality
borrowers. Due to high delinquencies, individuals were unable to payback there
loans
 Banks become wary of lending to each other. Credit dries up. Firms could not get
finance, could not get working capital, fired workers…

It is important to consider demand-side determinates to alleviate recessions:

Fiscal policy has a short-run impact compared to monetary:

Fiscal policy helps reduce volatility in the business cycle, however:
 Some public spending appears wasteful
 Accumulating debt now means higher taxes later
 Confidence: fears for solvency of heavily indebted countries
 Stabilising the business cycle should not be used as an excuse for running large
deficits.

Automatic stabilisers:
Automatically change in response to the state of the economy:
Tax Revenue: government’s set tax rates, but the taxes decreases in poor eco conditions
(lower incomes) and increases in better eco conditions (higher incomes)
Transfer Payments: welfare payments, especially unemployment benefits increase when
the economy is doing poorly and decrease when its doing well.

Discretionary fiscal stimulus:

Governments can make discretionary changes to spending or taxes to moderate the
business cycle:
Spending and Transfers (G,T) (transfers are taxes)

Discretionary changes to fiscal policy change the structural budget balance (the budget
balance that would prevail, assuming the economy was at full employment)

How the fiscal stimulus works:

Government spending is a component of aggregate expenditure:
AE = C+I+G+(X-M). Fiscal policy also affects other components of spending
 Consumption spending depends on income, net of taxes, and transfers (Y-tY-T)
 Planned investment spending
 Imports (M) depends on income Y
 Treat government spending G and
exports X as exogenous.

However, this ignores that consumers may

estimate that taxes rise in the future, so
they might save now to pay for the
expected future tax increase. Equally,
increase rates might increase, reducing I
and C.

The AE curve is flatter the larger the share of income spent on imports. The multiplier is
smaller then AE is flatter.

Fiscal policy is likely to be most useful just as an economy is about to enter a recession:
 Use resources about to be idled from fall in private demand
 Avoid consumer panic from spiralling unemployment
 Avoid collapse in investment.

Objectives of Monetary Policy:

Goals:
 The stability of the currency in Australia
 Maintenance of full employment
 Economic prosperity and welfare of the people of Australia.
RBA has independence from government: prevents manipulation of monetary policy for
political ends, and keeps monetary policy focused on its long-term goals.
Inflation target of 2-3% over the medium term
 Low target level of inflation reduces economic distortions
 Target provides an anchor for inflationary expectations
 Flexible target: difficult/costly to fine-tune inflation.
RBA operates in the overnight money market to keep the cash rate close to its target level.

Stabilisation of output close to potential keeps inflation stable, and maintains full
employment.
Stabilising inflation and output potential IS NOT a trade off.

Real values matter for aggregate expenditure.

Nominal IR = Real IR+Inflation.

The policy rule is steeper: therefore, the nominal rate of inflation rates faster than inflation.

Transmissions:
Intertemporal substitutions: A reduction in interest rates reduces the return on saving,
encouraging households to increase consumption. It is a relatively weak channel.
Investment: when IR are reduced, firms have more investment opportunities generating
high enough returns to spend it. The dwelling investment channel is very strong.
Asset-price channel: a decrease in interest rates boosts the price of stocks and real-estate
 An increase in asset prices raises wealth. Households spent some of the wealth
 For businesses, higher net worth makes it easier to borrow
Cash flow channel:
 A reduction in IR lowers repayment amounts for mortgages and business debt.
 Increase spending as interest payments decline
 Cash flow decreases for savers. But Australia is a net borrower, and savers typically
have a lower marginal propensity to consumer than borrowers.
Exchange rate channel: A reduction in interest rates reduces the return on Australian
financial assets relative to other countries. This causes a depreciation in the AUD. Less
people want to invest in aus cause lower return so lower demand for the dollar

An exchange rate depreciation:

 Makes Australian goods and services cheaper in foreign currency terms, increasing
export demand;
 Raises the price of imports, encouraging Australians to substitute domestic goods
and services for imports
 Note, higher import prices raises consumer price inflation

Public communication about objectives and outlook for monetary policy are also important
for modern central banking practice:
 Helps anchor inflation expectations
 Reduces uncertainty faced by the private sector
 Provides accountability and transparency

Random things:

The competitive market outcome maximises surplus as all trades for which MB>=MC take
place. In a competitive market, consumers keep buying provided MB>=P, and firms keep
selling as long as P>=MC; thus all mutually benficial trades up to MB=MC are realised.

For a monopolist charging a single price of 80 units in the case, it would have to drop its
price in order for consumers to purchase the good past the price p=80. Hence, past the price
p=80, marginal revenue is less than marginal cost, so it will not sell here. Likewise, all firms
will maximise profit and continue to sell up until MR=MC – so its maximised profit is where
MR=MC.
 Another way of saying this is that if the monopolist dropped its price beyond
MC=MR, MR is less than MC and it would not be maximising profit. Likewise, profit is
gained upto until MR>=MC. So its profit here is maximised at MR=MC/
Surplus is maximised when all trades for which MB>=MC. This occurs in a pareto efficient
competitive market. For a monopolist, profit is maximised when MR=MC – here at 20 units.
As the monopolists MR<P, this quantity will be less than the quantity required, so that
MB=MC for the last unit traded. For the units in between 20-25, the MB is greater than the
MC, so there are potential gains from trade. This results in a deadweight loss.

Because the monopolist needs to drop the price on all goods it sells to sell an extra unit, noit
just the marginal unit itself, it loses revenue from the lower price on all inframarginal units.
Provided q>0, MR<P. Hence, MR curve must lie below the average revenue curve (the
demand curve.

MR<P for selling above MR<P as you have to drop the price for every unit, not just the last
unit.

Deadweight loss is created by a monopolist because it charges a price greater than the
marginal cost of the last unit sold.

The slope of the demand curve does not tell us much about the price elasticity
Since marginal cost curve gets steeper as output increases, the total cost curve gets steeper
as output increases.
In a non-competitive market, equilibrium price and quantity may differ from equilibrium
price and quantity in a competitive market
When firms attracted by economic profits enter an industry, market supply increases and
market demand stays the same, and the result is a decline in the price.

The max a firm would be willing to pay is how much producer they would earn
The max a government would be willing to pay is how much consumer surplus they would
gain.

We know that under a monopoly, P=MB>MR. To max profit, MR=MC so we must have
P=MB>MR=MC, or MB>MC. The monopolist hence underproduces, so there will be a
deadweight lost.

For a monopolist charging a single price, it must drop its price on all inframarginal
consumers in order to sell an extra unit. Therefore MR<P, for all units but the very first unit
sold).

CPI overstates inflation:

- First year, you buy $120x2 clothing
- Assuming clothing is the only item in the basket, basket=240
- Second year, price increases to 125. The CPI assumes u keep buying the same
amount of clothing so the basket is 2x125.
In reality, you will buy less clothing because its more expensive.
  GDP measures the sum of the value added of all final goods and services produced in
an economy, over a period of time. GDP is the value of all final goods and services.
For GDP, it must say FINAL
 RBA is responsible for monetary policy, issuing Australia’s banknotes, and
maintaining the stability of the financial sector
 GDP is wages + profits sometimes.
 If P>MC = MR, there must be DWL.
 With first degree price discrimination, the monopolist will produce up until
MC=MB, not MC=MR.
 2nd degree price discrimination is when the consumer’s type is hidden information,
and the monopolist uses the different product packages/bundles to get the
customer to reveal their true valuation for their product.
 Monopolistically competitive industries have FREE ENTRY
 3rd degree PD is where the consumers types are known by the monopolist, who can
distribute between customer types.
 A market formed by many buyers and a first degree price discriminating monopolist:
achieves full efficiency, gets to an equilibrium quantity equal to the equilibrium
quantity in perfect equilibrium, and achieves a total surplus equal to the total
surplus in perfect competition.
 Nash Equilibrium: each player is doing the best they can, given what the other
player is doing.
 Long Run Average Cost is the lower envelope of short-run average cost curves.
 Long Run Marginal Costs are less than or equal too short run marginal costs.
 Tax revenue is not a DWL.
Positive externality DWL is the inside triangle in-between the two curves
Negative externality DWL is the outside triangle in-between the two curves.
 For game theory: the first player is the first number.

First practice quiz to review:

Q1,9,18,11,10,25,27,28,32,33,34,37
The hell is question 2 short answer?

Tips:
 READ THE QUESTIONS VERY FUCKING CAREFULLY.
 TRUST YOUR FIRST INSTINCT USUALLY.