Sunday, October 26, 2008

Chapter 25

Chapter 25 – Monopolist Competition and Oligopoly

Monopolistic competition – a) relatively large number of sellers b) Differentiated products c) Easy entrance and exit from the economy

Relatively large number of sellers – maybe 25 – 70 but not the thousands as in complete competition

No Collusion – enough firms that price setting/collusion is improbable

Independent action – No feel of interdependence, if one firm lowers prices, another one wouldn’t feel much of an effect

Differentiated Products – unlike pure competition, the products differ slightly by…Product Attributes, Service, Location (of purchase), Brand names and packaging – advertising and brand loyalty, Some Control over price – Sellers may pay a little more to choose a brand they think is better so not completely price takers

Easy Entry and Exit – because the firms are relatively smaller, it is not as hard to raise capital or achieve economy of scale

Advertisements – the goal of advertising is to differentiate products and encourage non-price competition – to make price less of a factor

Price and Output in Monopolistic Competition

The firms demand curve – Elasticity of demand faced by a monopolistically competitive firm is highly elastic but not perfectly elastic. Elasticity of demand depends on the number of rivals and the degree of product differentiation

The short run: Profit or Loss – mazimize profit/minimize loss by making MC = MR

The Long Run: Only a Normal Profit – In the long run, a monopolistically competitive industry will earn only a normal profit

Profits: Firms enter – Economic profit attracts new rivals, because entry to the industry is relatively easy, as more firms join, the demand curve will fall until it is tangent to the ATC curve, at this point the firms only produce a normal profit so there is no incentive for new firms to enter the business

Losses: Firms leave – Short term losses will push some firms out of the business, this will shift the demand curve (of the individual firm) to the right and thus restore normal profits

Complications – if a firm has sufficient product differentiation such that they cannot be copied, then they may be able to sustain modest economic profits in the long run or it might not be quite as free to enter the market due to product differentiation

Monopolistic Competition and Efficiency – the equality of price and marginal cost yields allocative efficiency

Neither Productive nor allocative efficiency – neither productive nor allocative efficiency occurs in long-run equilibrium. Profit maximizing price exceeds the lowest averacte total cost, therefore, the firms ATC is higher than optimal from society’s perspective. Also the Profit maximizing price exceeds marginal cost meaning that monopolistic competition causes an underallocation of resources, therefore it is not allocatively efficient either. Monopolistic competitors must charge a higher than competitive price in the long run to achieve a normal profit

Excess Capability – the difference between the minimum-ATC and the profit-maximizing ATC

Product Variety

Benefits of Product Variety – Product variety and product improvement of monopolistic competition may offset the inefficiency

Further Complexity – Graph 25.1 assumes no product development/fixed level of advertising, Competitive firm juggles price, product and advertising – In practice, this is determined by trial and error

Oligopoly

A Few Large Producers – when only a few companies 3-5 are in competition

Homogenous or Differentiated Products – May be a homogenous oligopoly or a differentiated oligopoly depending on whether or not the products are differentiated

Control over Price, but Mutual Interdependence – Price maker but must be careful that rivals wont undercut them significantly.

Strategic behavior – self-interested behavior

Mutual interdependence – each firms profit also depends on the prices/advertising of the other firms

Entry Barriers

Hard to enter because of often high capital requirements and need for economy of scale

Mergers – while sometimes firms grow into a oligopoly, often it is done by mergers. Beneficial because it makes the firm more monopolist in nature

Measures of Industry Concentration

Concentration Ration – percentage of total output controlled by the largest firm, when the largest four firms control over 40% of a market, it is considered an oligopoly

Localized Markets – CR’s are for the whole nation, but you can have oligopolies on a smaller level

Interindustry Competition – Sometimes industries compete with each other; for example motorcycle market competes with car market

World Trade – Import competition from foreign markets

Herfindahl Index – It could be possible if 4 companies controlled the whole industry that the four-firm CR was equal to a monopolized industry, the H index is the squared percentage market shares of all firms in the industry

The greater the H I, the greater the market power in the industry

Oligopoly and game theory

The study of how people behave in strategic systems is called game theory

Mutual Interdependence – Each firms profit depends on their pricing strategies and those of their rivals, one rivals high price strategy will only be profitable if the other one employs a high price strategy and vice versa

Collusive Tendencies – Collusion – cooperation with rivals (ie keep prices up for both firms)

Incentive to cheat – incentive to break price setting because then they could dominate the market

Three Oligopoly Models

Diversity of oligopolies – Tight Oligopolies – 3 or 4 control almost all, or Loose – 6-7 control 70% or so

Complications of interdependence – Firms cannot predict reactions so they cannot predict profit maximizing prices

Kinkead-Demand Thory: Non collusive Oligopoly

Match Price changes – If Company B and C react to Company As price decrease by matching A’s prices exactly then Arch’s demand and marginal revenue curves will look like straight lines

Ignore price change – Demand and MR curves faced by A will be straight lines, A would gain sales at the expensive of the other two companies, if it raised prices, A would lose many customers but not all of them because of product loyalty

A combined strategy

It is rational that B and C would lower their prices – but not raise them if Price was raised

Noncollusive oligopolies face the kinked-demand curve

Price Inflexibility

Either raising or lowering the price will result in smaller profits

Criticism of the Model – explains why price is pretty inflexible not what prices are set, When the macroeconomy is unstable, prices are instable. Price reductions lead to a price war

Cartels and other collusion – it would be profitable to collude and fix prices and create barriers to entry. Price and Output – each firm’s demand curve is indeterminate unless we know how the other firms will react. We will assume that they will match the price leaders price, so each demand curve is straight – therefore the same graph represents all three firms

If company A chooses where MC = MR = P (like a monopoly) the other firms will keep the same price and A’s demand curve will shift to the Left as customers shift loyalty

Each firm finds it profitable to charge where MC = MR, so they should collude to charge that price

Overt Collusions – the OPEC Cartel – cartel – a group of producers that typically creates a formal written agreement specifying how much each member will produce and forgo

Output must be controlled and divided up to maintain the agreed on price

OPEC controls 60% of oil traded internationally so they are able to drive prices up/lower them

Covert Collusion – also Tacit understandings – informal agreements about collusion

Obstacles to Collusion – Demand and Cost differences – difficult to agree on a price, Number of firms – The larger the number of firms, the harder it is to have a Cartel

Cheating – There is still a tendency to offer a lower price to steal competition

Recession – Slumping markets increase ATC

Potential Entry – Higher prices attract more firms

Legal Obstacles: Antitrust Law : prohibit cartels and price fixing

Price Leadership Model – Dominant firm initiates price changes and everyone else follows the leader

Leadership Tactics

Infrequent price changes – Price is changed only when demand and cost has been changed significantly,

Communications – communicates the need to raise/lower prices so other firms can react,

Limit pricing – Set prices below profit-maximizing level in order to discourage other companies from entering the industry,

Breakdowns in Price Leadership: Price Wars – Price leadership usually ends when one company undercuts the other companies and a price war results

Oligopoly and Advertising – each firms share of the total market is best determined by product development and advertising

Product development and advertising are less easily duplicated then price cuts and therefore can produce longer lasting gains

Oligopolists generally have capital to put into product development

Advertising is prevalent in monopolistic and Oligopolistic competition

Positive effects of advertisements – Spreding info about products helps people make rational discussions and break up monopolies, enhances competition – greater economic efficiency

Negative effects of advertising – some ads convey little about product attributes, two costly advertising campaigns can be canceling

Oligopoly and efficiency

Productive and Allocative efficiency – P – minimum ATC

Chapter 24

Chapter 24

Pure Monopoly – when a single firm is the sole producer of a product for which there are no close substitutes

Single Seller – When no other firms sell anything even similar

No close substitutes – a consumer who chooses not to buy the mopolists product must do without

Price maker – unlike a firm in competition which is a price taker, a monopolist sets it price

Blocked Entry – has no immediate competitors because of economic, legal or technological barriers preventing them from entering the industry

Nonprice competition – monopolists with standardized products (ie electricity) advertise with public relations while differentiated products (such as MS Windows) advertise their products attributes

Dual Objectives of the study of Monopoly

Barriers to Entry –

Economies of Scale – It is difficult for firms to break into the market when large, expensive technologies are needed

Natural Monopolies – when the market demand curve cuts the long run ATC curve where ATC ‘s are still decreasing

Legal Barriers to Entry – Patents and Licenses

Patent – aim to protect the inventor from people who wish to make money on the product without helping develop it, last for 20 years, the profits from one patentable item can lead to the R&D necessary to produce another

Licenses – Gov’t gives licenses to radio stations through the FCC etc

Ownership/Control of Essential resources - ie The International Nickel Company owned all the Nickel deposits

Pricing and other Strategic Barriers to entry – If another company tries to enter the market, the monopolist can respond by slashing prices

Monopoly Demand – Three Assumptions – Monopoly is secured, not licensed/regulated, single price monopoly

Unlike the competitive seller that faces a perfectly elastic demand, the monopolist faces a demand curve of the whole market

Marginal Revenue is less than Price – can only change the quantity demand by changing the price, MR <>

The Monopolist is a Price Maker – Firms with downward sloping demand curves are price makers

The Monopolist sets prices in the elastic Region of Demand – TR test for price elasticity states that if TR goes up when price goes down then the demand is elastic, a monopolist will never set prices such that price reductions would cause a TR decrease

Output and Price Determination

Cost Data – Assume it hires resources competitively and employs the same technology as a competitive firm would

MR = MC rule – If producing is preferable to shutting down then the monopoly will produce until MR = MC

To find the price that the monopoly would charge, see at what quantity MC and MR are equal and then find the price from the demand curve

No Monopoly supply curve

The pure monopolists MC curve is NOT its supply curve, the Monopolist has no supply curve

The monopolist equates marginal revenue and marginal cost to determine the best output

++++THESE NOTES NOT COMPLETE FOR CHAPTER 24++++

Monday, October 6, 2008

Chapter 23

Chapter 23 – Pure Competition

Group Industries into

Pure Monopoly – One firm is the sole seller of a product/supplier of a service

Monopolistic competition -  A large number of sellers sell differentiated products, this protects them from competition

Pure competition – A large number of firms producing similar goods

Oligopoly – Only a few sellers of similar or differentiated products such that they are affected by the actions of their rivals

Pure  Competition – Very large numbers of providers offered in markets,  standardized product – if the price is the same, buyers are indifferent to supplier, Price Takers – individual firms exert little or no control over product price, cannot change supply significantly so they have to accept the price given by the market, Free entry and exit – No significant legal, technological, financial or other attributes can stop them

Relevance – Although relatively rare, apparent in agricultural products etc and as a relative model to analyze efficiency

Demand as seen by a purely Competitive seller

Perfectly elastic demand – for each competitive firm

Average, total and Marginal Revenue – Demand Schedule is also its average revenue schedule

                Total revenue – price*quantity

                Marginal Revenue – the extra revenue generated by selling one more of an object

Graphical Portrayl – D is horizontal, TR is a straight slope up increasing by Marginal revenue

Profit maximization in the short run – Can only adjust its output, only through changes in the amount of variable resources (materials, labor) it uses

Total-revenue – Total cost approach – Profit maximization case – The producer will react to the market price by asking If they should produce the good and if so in what amount and what profit they will realize

Total revenue and total cost are equal where the total cost and total revenue curves intersect, here total revenue covers all costs but no profit is realized, this is the break-even point

Marginal-Revenue, Marginal-Cost technique

Should produce any unit who’s Marginal Revenue is greater then its marginal cost

At lower end of production, MC < style="mso-spacerun:yes">  There is a point where MC = MR, <= That is the point where you want to be as long as producing is preferable to shutting down

Three Characteristics of the MR = MC rule – 1) Only applies if producing is preferable to shutting down 2) The rule is accurate for any of the industry types 3) The rule can be restated as P = MC when applied to a purely competitive firm because demand is pretty much perfectly elastic at the market price

If you are going to sustain losses, if the marginal revenue per item is greater then the AVC, then you should produce

If the AVC is greater than the price always then you should shut down

Marginal Cost and Short-run Supply – Quantity supplied increases as price goes up

Very Important – know what should happen at every price on 23.6

Generalized depiction – Graph 23.6 – It helps to think that Price is the independent variable (price takers) and that ATC, AVC and MC curves are dictated by production techniques/demand.  MC = MR =  P because the market is perfectly competitive

At P1 – the firm should not produce because P1 <>

At P2 – P2 = the minimum AVC so the firm should produce that quantity such that MR = MC, it will lose its fixed cost

At P3 – P3 is on the MC cost curve such that MR = P = MC, this would minimize its short term loses

At P4 – where MC = ATC, the firm will just break even, Normal, but no Economic profit

Above P4, the firm will have an economic profit because MC is greater than ATC, Should be where MC = P = MR

Points along the MC graph are the optimal upsloping supply curve of the firm.  At any point below where AVC intersects MC, the company should shut down

Diminishing returns, production costs and product supply – b/c of the law of diminishing returns, marginal costs rise with output (and thus a higher price must be provided)

Changes in supply – costs go up, supply goes down

Firm and Industry: equilibrium price – In a purely competitive market – equilibrium price is determined by total suplly and demand, must sum supply curves then calculate the market supply schedule which determines product price

Chapter 22

Chapter 22 – The Costs of Production

Economic Costs

The Economic/Opportunity cost of an object is the value or worth of the resources as produced in their best alternative use

Explicit and Implicit Costs

From a firms standpoint these are the payments a firm must make or incomes it must provide to attract the resources it needs away from alternative production opportunities

                Explicit Costs – monetary payments for resources

                Implicit costs – opportunity costs of using its self-owned, self-employed resources

Normal Profit as a (implicit) cost – You forgo other applications of your entrepreneurial talent

Economic Profit or Pure Profit

Economic profit is total revenue less any economic costs (Explicit, Implicit, Normal)

Short Run Production Relationships – since plant size is fixed, we will be focusing on labor-output relationship

Total Product (TP) – total quantity or total output of a particular good produced

Marginal Product (MP) – extra output or added product associated with adding a unit of a variable resource to the production process

Average Product (AP) – total products/units of labor

Law of diminishing returns – at a certain point, the amount you get out will start decreasing relative to the amount you put in

Short Run Production Costs

Fixed Costs – don’t depend on quantity produced, ie rent

Variable Costs – Change with the level of output, ie labor, fuel, etc

Total Cost – Sum of fixed and variable costs

Per-Unit or average costs

AFC – average fixed cost is found by dividing total fixed costs by quantity

AVC  - average variable cost is total variable cost divided by quantity (declines initially, has a minimum where it is most efficient, then increases)

ATC – Average total cost is the Total Cost/quantity

Marginal Cost – the cost of producing the last item, also the cost saved by not producing one more, Firm decides whether or not to produce more

Relation of MC to AVC to ATC

MC curve intersects AVC and ATC curves at their minimum points

When the marginal cost per unit is less than average, ATC will fall

As long as MC lies below ATC, ATC will fall and when it is above ATC will increase, thus it intersects at the lowest point

Shifts of the Cost Curves

At each level of output, AFC is greater (and thus ATC would increase)

A change in labor/resource costs would affect ATC and AVC

Long-Run Production Costs

Firm Size and Costs – at first it will cost ATC to decrease (greater efficiency) but eventually it will cause ATC to increase if there are too many plants

Cost Curve – At certain intervals of quantity the firm should increase production capabilities

Economies and diseconomies of scale – Law of diminishing returns does not apply in the long run, (diminishing returns assumes one resource is fixed), assume long-run ATC curve is U shaped

Economies of Scale – As plant size increases, a number of factors will for a time lead to a lower average costs of production

Labor specialization – more efficient

Managerial Specialization - Managers should be overseeing as many people as they can

Efficient Capital – many of the most efficient machines are too large and expensive to afford on the small scale

Diseconomies of Scale

The difficulty of managing and controlling a firms operations as it becomes a large-scale producer

More Red Tape

Constant Returns to Scale -  a period between economy of scale and diseconomy of scale where regardless of the scale, the ATC is the same

Minimum Efficient Scale and Industry Structure – MES – lowest level of output at which a firm can minimize long-run average costs

Given consumer demand, efficient production will be achieved with a few large-scale producers

When economies of scale are few and diseconomies come into play quickly, the minimum efficient scale occurs at a lower level of output

When economies of scale extend beyond the market size, natural monopolies are formed

Preferred stock – get benefits before others, get better dividends

Chapter 21

Chapter 21 – Consumer Behavior and Utility Maximization

Income and Substitution effect

Income Effect – The effect that as price declines, a consumer’s “real income” increases, their purchasing power increases and therefore the demand for the product also increases

Substitution effect - When the price of a good decreases, it becomes a relatively better buy and thus more attractive to the buyer

The combination of the Income effect and the Substition effect drives the law of demand

Law of Diminishing Marginal Utility – we already studied this – this is the law that as you buy more and more of an item, subsequent purchases are worth less and less

Utility –the want-satisfying power of a good, not necessarily the usefulness (ex Paintings), Utility of goods is much different for different people

It is difficult to quantify (b/c it is subjective) but utils are units of satisfaction

Total Utility and Marginal Utility

Total Utility is the number of utils a consumer derives from a particular number of goods (of the same kind,)

Marginal Utility – the number of extra utils a consumer receives from buying more of something

Marginal Utility, Demand and Elasticity

How does the law of diminishing marginal utility explain why the demand curve for a given product slopes downward?  If the marginal utility of an object decreases, then the things are worth less and less, thus they will be willing to pay less and less for them

Consumer Choice and Budget Constraint

Rational Behavior – People try to maximize their utils of satisfaction from their income

Preferences – Consumers have preferences and know the utility they will get from successive, marginal purchases

Budget Constraint – At any time, the consumer has a limited amount of money to spend

Prices – Goods are scarce relative to the demand for them, so every good carries a price tag

Utility Maximizing rule – The consumer should allocate his or her money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility

Marginal Utility per dollar –to make the amounts of extra utility derived from differently priced goods comparable marginal utilities must be put on a per dollar spent basis

Algebraic restatement: The Marginal utility per dollar spent on A is the MU of the product/price so

(MU of product A)/Price of A = (MU of Product B)/Price B = (MU of Product C)/Price C etc

Utility Maximization and the Demand Curve

Deriving the Demand Schedule and Curve – By looking at the Marginal Utility per dollar data we can find how many items a consumer will purchase at any particular price based on their utility

Income and Substitution effect revisited – Switch between products in order to satisfy the Utility maximizing rule

The Value of Time – Time has a value so when considering the price of goods/services, include the price of the persons time (hourly wage).  For example it makes since for a business executive to fly somewhere  rather than take a bus there because while the cost of the bus may be quite less, the cumulative cost of fare + time spent*hourly wage is much greater for the bus

People eat more at buffet meals because the marginal utility is positive and the price is zero

Budget Curves – The relative amount of two goods that a consumer can buy

Indifference Curves – All the combinations of two products that will yield the same total satisfaction or utility.  They are Downsloping, Convex to the Origin – the slope measures the maginal rate of substitution

If we superimpose the budget line on an indifference map (set of indifference curves that yield different total utilities) The point of tangency between the budget line and one of the indifference curves is the equilibrium position

Chapter 20

Chapter 20 – Elasticity of Demand and Supply

Law of demand – dictates that consumers will buy more or less of something if the price is lowered/increased.

The price Elasticity of demand is the measure of how responsive the quantity demanded is to a change in price

Price Elasticity Coefficient and Formula

                Ed = (percentage change in quantity demanded)/(percentage change in price)

Percentages – use them because they give you a better idea of relative prices

Elimination of minus sign – b/c elasticity of demand is always negative, most people don’t bother writing it in

Elastic Demand – Demand is elastic if a specific percentage change results in a larger change in quantity demanded

Inelastic demand – If a specific percentage change in price causes a smaller change in quantity demanded then demand is inelastic

Unit elasticity – if a percentage change in price causes the same percentage change in demand

Extreme Cases/Perfectly inelastic – in the case that a change in price causes NO CHANGE in demand, a good is known to be perfectly inelastic.  A good example is insulin or an addict for heroin.  This only really occurs for a supplier in an extremely competitive market when they lower prices a little

However there is a problem when deciding what price should be the reference point to calculate elasticity of demand. If you calculate a 5-4 dollar change then going one way it is a 20% decrease the other way is a 25% increase.  You calculate Elasticity from the midpoint of the two prices (4.5 dollars)

Ed = ( Change in quantities/(average quantities)) / (change in price/(average price))

Graphical Analysis – Elasticity varies for price ranges, typically more elastic for the higher price ranges than towards the lower price ranges.  This is because the original reference quantity is quite small in comparison to large values so a small change in price results in a larger percentage change.  The opposite is true for larger values

The flatness/steepness of the demand curve is not a good way to judge elasticity because it is based on absolute (instead of relative) changes in price/quantity.

Total Revenue test – TR is the total amount the seller receives from the sale of a product in a particular time period,  TR  = price * quantity

If demand is elastic then a decrease in price will increase total revenue and vice versa

If demand is inelastic – a price decrease will decrease total revenue and vice versa.  This is because lowering the price will have a relatively small effect on quantity.

Unit elasticity – An increase or decrease in price leaves total revenue the same

Price Elasticity and the Total-Revenue Curve

If total revenue moves in the opposite direction as price then demand is inelastic, if it doesn’t change then it is unit-elastic

Determinants of Price Elasticity of Demand

                Substitutability – if something else can be substituted then it is more elastic

Proportion of Income – the higher the price of the good relative to the consumers income, the more elastic

Luxeries versus necessitiesThe more its considered a luxury, the greater the elasticity because people can easier justify it not worth purchasing

Time – Product demand is more elastic the longer the time period under consideration, If something changes an established price, initially demand won’t be especially affected, later people will find a way to work around it

Applications of Price-elasticity of demand

Large Crop Yields – demand for farm products is highly inelastic so a good growing season actually decreases total revenue for the farms

Excise Taxes – The higher price resulting from imposing an excise tax can decrease the sales of an object – and thus the tax revenue.  Therefore, most excise taxes are on fairly inelastic goods – Liquor, gasoline, cigarettes etc

Price-elasticity of supply

Es = (Percentage change in quantity supplied)/(Percentage change in price)

Price elasticity of supply depends on the ease and speed at which producers can reallocate resources

Distinguish between short term and long term elasticity of supply

The market period – the period of time before the suppliers can react with a change in quantity supplied, for example one growing season

The short run – the amount of time too short to change production capacity but possible to change production efficiency

The long run – the time period necessary for an industry to make changes in quantity supplied

There is no total-revenue test for elasticity of supply.  Supply shows a direct relationship between price and quantity supplied, regardless of the elasticity, price and total revenue move together

Cross Elasticity and elasticity of income

                Cross Elasticity – measures how responsive one product’s demand is to the demand of another

Ec = (Percentage change in quantity of Product X)/(Percentage change in quantity demanded of product Y)

Substitute Goods – If the Cross Elasticity is positive then they are substitute goods.  When Cross elasticity is negative, they are Independent goods.

In the case that two substitute goods are in competition, the government will try to maintain this competition because otherwise, the price could be raised if they merged

Income elasticity of demand – the measure of how much consumers react to a change in their income by buying more or less of a good

Ei = (% change in quantity demanded)/(% change in income)

                Normal Goods – Usually Ei is positive for normal/superior goods

                Inferior Goods – A negative income-elasticity coefficient designates an inferior good

Chapter 5

Chapter 5 – The US Economy: Private and Public Senators

The US has 109 households – a housing unit, they are the ultimate suppliers of all economic resources and the major spenders in the Econmy

The Functional Distribution of Income – how income is apportioned through wages, interest, and profits.  Largest source of income of households are wages and salaries paid to workers (not capital!)

Personal Distribution of Income – How the nation’s money income is divided among individual households (ex in 2001 the poorest 20% of households received only 3.5% of the income while the richest 20%)

Households as Spenders – how households spend their money

Personal Taxes – about 13% of income (in 1941 it was only 3%)

Personal Savings – Aftertax income that is not spent, accounts for about 3%... proportionate with income (higher earning people save more of their money).  Dissave is to draw more from savings then you put in

Personal Consumption Expenditures – shit that you buy … more than 80%.  12% of which are durable goods – goods that keep on giving ie Automobiles, computers, furniture.  29% are nondurable goods (stuff that is used up within 3 years) – food, clothing, gasoline. 59% is for services (medical, lawyer fees etc)  Because the last percentage is so high, the US is called a Service-oriented economy

Buying the first share of a stock is an investment but otherwise its just a transfer in money, buying a car for personal use is not an investment but buying one for business is

Primary Economy – Producing Raw materials

Secondary Economy – Industrialization, using the goods

Tertiary Economy – service oriented economy

The Business Population

Plant – The physical place where shit is built, sold or services are provided

Firm – a business entity which owns plants

Industry – a grouping of firms that produce similar products (ie the auto industry includes Ford, Chevrolet, Honda etc)

Horizontal Integration – A firm produces similar goods (ie the CocaCola produces Coke, Vault etc)

Vertical Integration – when a company trys to control a market by controlling different types of the same general market – (ie Gap has Banana Republic for the high end market, Gap for the mid market, and Old Navy for cheap stuff)

Conglomerate – when a company produces stuff for a bunch of different markets (ie General Electric)

Legal Forms of Businesses

Sole Proprietorship – a business owned and operated by one person,

less paperwork, people work harder because they directly benefit, more freedom of action.  However its difficult to grow because because finances are limited for R&D, also there’s a lack in specialization.  Most importantly there’s unlimited liability, if the business fails the owners go bankrupt too

Partnership – two or more individuals own and operate –

Same pros and cons of Sole Proprietorships except to a lesser extent, does give more capitol,

Also limited versions – REIT – Real estate investment trust – someone else manages

Corporation – a legal creation that can acquire resources, own assets etc etc.  it is distinct from and separate from the individual stockholders who own it, hired managers usually run the show

Can raise vast amounts of capitol compared to sole proprietorships and partnerships,  can sell Stocks (shares of ownership) and Bonds (Promises to pay someone an amount later).  Stocks and Bonds are called securities

By selling securities, the business is less liable because the stock owners would take a lot of the fall

Limited Liability – Stock owners only stand to lose however much they paid for their stock, they cannot be personally sued

Legally immortal – sale of stock does not disrupt the continuity of the company

Can have more red tape but overall it is more effective/efficient

Double Taxation – Dividends (money stockholders receive from profits) are taxed as corporate profits and as income for the stockholders

Hybrid

LLC – limited liability company – Typically where a partnership enjoys protection from the usual liability, limited life span of 30-40 years

S Corporation – 75 or fewer stockholders, avoids double taxation and enjoys limited liability

Principal-Agent Problem

Principals (stockholders) and Agents (managers of the corporation) may have a conflict of interest.  Stockholders want to maximize profits while managers want to earn larger salaries expand the company

Try to align interests by offering stock as part of the salary, this in turn may lead to an attempt to inflate stock prices leading to Enron type situations

While the majority of businesses are sole proprietorships, Corporations produce the majority of goods/services

The Public Sector – governments role

Provides the Legal structure – sets the legal status of business enterprises, ensures property rights and helps allocate resources, establishes a medium of exchange (money)

Maintains Competition – protection from monopolies (some monopolies are only regulated for example local power suppliers)

Redistributing Income – Distribute more than what the market would naturally give to the least skilled of the workforce by

Transfer Payments – ie Welfare, they give money to the destitute and dependent

Market Intervention – Give farmers above natural market prices/minimum wages

Taxation – Sliding tax scale taxes the rich more than the poor (supposedly)

Reallocating Resources – Market failure occurs when the market creates too much of one thing or not enough of some necessary goods/services

Spillovers or Externalities – in a competitive market sometimes costs or benefits might not just be particular to a buyer/seller interaction.  Ie by producing product A you fuck up the water supply thus fucking up the fishing industry down river and then the hippies get mad

Spillover Costs – Production/consumption costs that a third party bears,  Ie pollution

Correction for Spillover Costs

                Legislation – EPA type stuff, makes companies at least somewhat liable

Specific taxes – ie taxing each unit of pollution

Spillover Benefits – Education and vaccination benefit not only the direct receivers

In order to increase spillover benefits the gov’t can subsidize the sale of items that have spillover benefits, ie tax benefits for Hybrids

Subsidize suppliers – Ie subsidizing state universities/offering scholarships

Provide goods via gov’t – ie free or subsidized flu vaccines

Public Goods and Services

Private goods have two characteristics: Rivalry and excludability.  Rivalry – When one person buys and consumes a product it is unavailable for someone else. Excludability – buyers who are willing/able to pay the price get the benefit

Public goods are something that everyone can enjoy without creating competition (ie air hopefully, and your mom)

Free rider problem – people can receive benefits without paying a price

Quasi Public goods

Education, streets, highways—things gov’t provides because if left to the market they would be underproduced b/c of the spillover benefits

The Reallocation Process – How are resources taken from the private sector to the public sector? Tries to reduce private demand for the item by levying taxes, by diverting purchasing power from private spenders to gov’t taxes remove resources from private use

Promoting stability

Unemployment – May try to augment private sector spending so that the total spending is enough to achieve

Inflation – General increase in the price of goods – increase when spenders try to buy more than the countries capacity to produce, gov’t would try to cut its spending to reduce overall spending, may also try to increase interest rates so as to increase interest rates and private borrowing and spending

Adding Gov’t to the circular flow model

Put gov’t in the center

Households – exchange goods and services for taxes

Product Market – exchanges expenditures for goods and services

Resource market – Exchange expenditures for resources

Businesses – exchange goods and services for net taxes

Gov’t Purchases and transfers          

Gov’t purchases – are exhaustive – directly absorb resources and are part of domestic output

Transfer Payments – nonexhaustive – do not directly absorb resources, ie social security – the benefactors do not make a contribution to the economy in return for them

Federal Finance

Federal expenditures – 4 very important ones – Pensions and income security, national defense, health, interest on the public debt

Federal tax revenues - Personal Income tax – levied on taxable income after business expenses, charitable contributions etc are deducted.  It is a progressive tax meaning it has higher tax brackets for people with larger incomes

Marginal tax rates – the amount of additional taxes levied when you go up a tax bracket, ie the marinal rate of 1-14k is 10 percent, 15% on 14k to 57k etc

Average tax rate – the total taxes payed divided by athe amount of taxable income

Payroll Taxes – taxes based on wages and salaries, used to finance meicare and Social Security

Corporate Income tax – levied on a corporations profit – usually 35%

Excise taxes – Taxes on commodities or on purchases.  Sales taxes are on everything, excises are only on special goods like gas, tobacco etc

State and local finances

47% generated from sales tax, also local income taxes

Education spending accounts for 36 percent

Local Finances – obtain 72% from property taxes

Local spending is about half and half local/federal taxes