5 Ec Midterm 2
Review
P (or social MB) = (Social) MC is necessary for efficiency
Requirments:
Perfect competition
o Profit maximization: MR=MC
o Perfect Competition: P=MR
o Imperfect Competition: P>MR
No externalities/ Public goods problems
o Social MB=Private MB
o Social MC=Private MC
No informational Problems
o Public good aspects of information
o Asymmetries
Adverse selection
Moral hazard
Things to know
Imperfect Competition
Uniform pricing monopolist
o Twice as steep rule
If P=A-BQ
MR =A-2BQ
o If C(q) = Fixed Cost + cQ [MC=c) then
Q= (A-c)/2B (half of what the competitive industry would
produce)
o Know how to calculate CS, PS, and DWL in this case.
Price Discrimination
o People pay different prices for the same good.
o Some examples
2-part pricing
Quantity discounts
Bundling
Time-of-day pricing/ age parking
Versioning (customizing a product so that it is more appealing to
people)
o Price Discrimination is good for market efficiency because it moves Q
closer to competitive level.
It also allows exploitation of scale economies but intensifies
competition
However, the surplus that is made goes directly to the producers,
not the consumers.
Imperfect competition
Monopolistic Competition
o Lots of Firms with Small Markets
o Differentiated but close substitutes
o economies Scale not exploited
o Incentive to price discriminate but that intensifies competition
Oligopoly
o Nash Equilibrium
o Cournot-Identical products and quantity competition
Q= N/(N+1)Q competitive
o Bertrand: Price Competition
If products are identical then it is easy to figure out,
Q=Q competitive even if N=2
There is a big incentive to differentiate products
Know both the Cournot and Bertrand Theories/Models
Externalities
Distinction between marginal social benefit/cost & marginal private benefit/cost
due to third party effects
o Negative externalities Over Production
o Positive externalities Under Production
Treatment: Introduce Price Signal via Tax or Tradable Permit
Optimal pollution reduction allocation equates MC at each point
o MC1=MC2 and Q total = Q1 + Q2
And equates MB at Q total with MC1 and MC2
When the MB=MC then that is the right amount of pollution to produce
Information Problems
Information is a public good
o How to get it produced?
o Must rely on Second Best
Subsidies
Patents and copyrights
Information asymmetries
o Adverse selection- prices sort (adversely) as well as balance supply and
demand
o Moral hazard Impossible to write efficient contracts between principal
and agent
o Particularly important in insurance markets