Is there a compensating marriage differential -- are women compensated for the relatively
unpleasant task of marriage? (HINT: what happens to women’s income when they divorce?) (HINT:
what happens to women’s happiness when they divorce?)
Finance: risk vs. return
Proposition: In equilibrium, differences in the rate of return reflect differences in the riskiness of the
investment, e.g. risk premium
Expected return = (E[P t+1 ] - P t )/P t
The higher return on a risky stock is known as the risk premium
In equilibrium, differences in the rate of return reflect differences in the riskiness of an
Risk premia are analogous to compensating wage differentials: just as workers are compensated
for unpleasant work, so too are investors compensated for bearing risk
Stock volatility and returns
DISCUSSION: VIX measures volatility. Why does higher volatility lead to lower stock prices?
(HINT: investors must be compensated for bearing risk)
Historical equity risk premium
Gov’t bonds are considered risk-free, they return 1.7% while stocks return 6.9%. The difference
is a risk premium that compensates investors for holding the more risky stocks.
Monopoly (different story, same ending)
Definition: A monopoly firm is one that faces a downward sloping demand curve.
They produce a product or service with no close substitutes; they have no
rivals; and there are barriers to entry, so no other firms can enter the industry.
Proposition: In the very long run, monopoly profits are driven to zero by the same competitive
Entry makes demand more elastic (P- MC)/P=1/|e|, which forces price back
down towards MC. Example: 1983 Macintosh was priced very high when it first
appeared. Eventually, though, Windows copied the OS, and price was forced
Alternate intro anecdote
In 1924, Kleenex tissue was invented as a means to remove cold cream.
After studying customer usage habits, however, the manufacturer (Kimberly-Clark) realized that
many customers were using the product as a disposable handkerchief.