Microeconomics

• ·Modeling: simplified representations of reality that allow key relationships to be highlighted. The “rational consumer” model does not describe real people exactly but helps to understand the logic...
• ·Mathematical analysis: equations, graphs, optimization. Allows precise formulation of hypotheses and derivation of consequences.
• ·Empirical testing: comparing model predictions with data. Econometrics—statistical methods for analyzing economic data.
• ·Experiments: laboratory and field. Behavioral economics actively uses experiments to study real behavior.
• ·For business: understanding market structure, pricing, competitor analysis, investment decision-making.
• ·For the investor: industry analysis (competitive dynamics, entry barriers), company evaluation (costs, profitability), understanding consumer behavior.
• ·For the citizen: assessment of economic policy, understanding of market mechanisms, critical attitude towards populist promises.
• ·For personal finance: making decisions about career, consumption, savings, investments.

• ·All resources on guns: maximum guns, zero butter
• ·All resources on butter: maximum butter, zero guns
• ·Intermediate combinations: some resources on guns, some on butter
• ·Productive efficiency: The economy operates on the production possibility frontier, not inside. All resources are fully utilized, there is no "downtime". A point inside the PPF means that more of b...
• ·Allocative efficiency: Of all the points on the PPF, the one is chosen that maximizes societal welfare. Not only are we producing efficiently, but we are producing the "right" combination of goods—...
• ·Outward shift (to the right)—economic growth. Reasons:
• ·Increase in resources: population growth (labor), capital accumulation, discovery of deposits
• ·Technological progress: same resources produce more
• ·Improvement in human capital: education, health
• ·Institutional improvements: protection of property rights, rule of law
• ·Inward shift (to the left)—economic decline. Reasons:
• ·Destruction of capital: war, natural disasters
• ·Population decline: epidemics, emigration
• ·Institutional degradation: corruption, conflicts
• ·Resource depletion: without replacement
• ·Absolute advantage: A country can produce a good with fewer resources than another. Country A produces both guns and butter more efficiently than country B—it has an absolute advantage in both goods.
• ·Comparative advantage: A country can produce a good at a lower opportunity cost. Even if country A is better at everything, country B has a comparative advantage in that good where its "lag" is sma...
• ·Two goods: The real economy produces millions of goods. Expanding to many goods is technically possible, but not visually representable.
• ·Static: The PPF shows possibilities at a given moment. Dynamics, expectations, and uncertainty are not considered.
• ·Full employment: The PPF assumes the possibility of full utilization of resources. In reality, reaching the frontier is a complex task.
• ·Resource homogeneity: The model simplifies differences in the quality of resources.

• ·What to produce? That which people are willing to buy. If consumers want more smartphones, the price rises, production becomes more profitable, and resources flow into this sector.
• ·How to produce? In the most efficient way. Competition forces firms to minimize costs—otherwise they will lose to their competitors.
• ·For whom to produce? For those who can pay. Distribution is determined by incomes, and incomes—by ownership of resources and their productivity.
• ·Private property: resources belong to private individuals and firms
• ·Freedom of enterprise: anyone can start a business
• ·Competition: many sellers and buyers
• ·Price mechanism: prices coordinate the decisions of millions of agents
• ·Profit motive: profit directs resources to their most valuable uses
• ·Limited role of the state: protection of property rights, enforcement of contracts
• ·What to produce? The plan determines this—a document compiled by planning bodies. The state sets priorities, not consumers.
• ·How to produce? Directives determine this—enterprises receive assignments on output, technologies, suppliers.
• ·For whom to produce? Distribution is also controlled by the state—through wages, quotas, queues, privileges.
• ·State ownership: of the means of production
• ·Centralized planning: Gosplan determines quantities, prices, distribution
• ·Absence of market prices: prices are set administratively, do not reflect real scarcity
• ·Labor control: allocation by professions, mobility restrictions
• ·Ideological motivation: instead of profit—plan, socialist competition
• ·Incentive problem. Without profit and competition, enterprises have no incentive to reduce costs, improve quality, or introduce innovations. Fulfilling the plan by quantity is the only criterion, l...
• ·Role of the market: most goods and services are produced and distributed through the market.
• ·Role of the state:
• ·Legal framework: protection of property rights, enforcement of contracts, antitrust regulation
• ·Public goods: defense, infrastructure, law and order—the market does not produce these or produces them insufficiently
• ·Correction of market failures: externalities (pollution), information asymmetry
• ·Redistribution: taxes, social programs, fighting poverty
• ·Macroeconomic stabilization: monetary and fiscal policy
• ·Liberal market economy (Liberal Market Economy, LME): USA, United Kingdom. Emphasis on the market, flexible labor relations, developed financial market, short-termism.
• ·Coordinated market economy (Coordinated Market Economy, CME): Germany, Japan, Scandinavia. More coordination between firms, banks, trade unions. Long-term relationships, investment in skills.
• ·State capitalism: China, Singapore, Russia, Saudi Arabia. The state is a major owner and active player in the economy. State companies in strategic sectors, industrial policy.
• ·Efficiency: how fully resources are used, how optimal their allocation is.
• ·Growth: how quickly productive potential increases.
• ·Stability: whether the economy is prone to crises, inflation, unemployment.
• ·Fairness: how the fruits of economic activity are distributed.
• ·Freedom: what freedom of choice individuals have.
• ·Sustainability: whether long-term consequences, environment are taken into account.
• ·The institutional environment determines the rules of the game. In different systems—different risks and opportunities.
• ·The role of the state affects sectors: regulated industries, government contracts, subsidies create specific investment opportunities and risks.
• ·Political changes can shift the system: privatization, nationalization, deregulation change the rules and value of assets.

• ·Income Effect: when price rises, real purchasing power falls—you can afford less.
• ·Substitution Effect: as price rises, the good becomes relatively more expensive compared to alternatives—you switch to substitutes.
• ·Diminishing Marginal Utility: each additional unit provides less satisfaction—you are willing to pay less for more.
• ·Shift to the right—increase in demand: at any given price, consumers want more.
• ·Shift to the left—decrease in demand: at any given price, they want less.
• ·Income: for normal goods, income growth → shift to the right. For inferior goods—shift to the left.
• ·Prices of substitutes: rise in price of a substitute → shift to the right (consumers switch to your good).
• ·Prices of complements: rise in price of a complement → shift to the left (buy less of both).
• ·Tastes and preferences: fashion, advertising, information → shift in any direction.
• ·Expectations: expectation of rising prices → shift to the right today.
• ·Number of buyers: population growth, new markets → shift to the right.
• ·Change in the price of the good itself—movement along the curve. Demand (the curve) does not change; only the quantity demanded (a point on the curve) does.
• ·Change in other factors—a shift of the entire curve. At every price, the quantity is new.
• ·Forecasting: how will changes in factors affect sales? Rising gasoline prices → falling demand for large cars, rising demand for hybrids.
• ·Pricing: understanding the demand curve allows you to optimize price to maximize revenue or profit.
• ·Marketing: advertising and branding aim to shift the demand curve right and reshape it (decreasing elasticity).
• ·Policy: subsidies shift demand to the right (electric vehicle grants), taxes affect demand by changing price.

• ·Profit motive: higher price means higher profit, which is a greater incentive to produce.
• ·Increasing marginal costs: to increase production, less efficient resources must be used — costs rise. Producers are ready to do this only at a higher price.
• ·Entry of new producers: high price attracts new participants, increasing supply.
• ·Shift right — increase in supply: at every price, producers are willing to sell more.
• ·Shift left — decrease in supply: at every price, willing to sell less.
• ·Resource prices: increase in prices of raw materials, labor, energy → costs higher → shift left.
• ·Technologies: improvement in technology → costs lower → shift right.
• ·Prices of alternative goods: if a firm can produce $X$ or $Y$, increase in price of $Y$ → part of capacity switches → supply of $X$ shifts left.
• ·Expectations: expectation of price increase → hold back goods today → shift left.
• ·Number of sellers: entry of new firms → shift right, exit → shift left.
• ·Government: subsidies → right, taxes → left, regulation affects variably.
• ·Weather and natural factors: for agricultural products — a critical factor.
• ·Immediate period: supply is fixed — what is in stock. The curve is vertical.
• ·Short-run period: firms can change output, but capital (factories, equipment) is fixed. The curve is relatively steep.
• ·Long-run period: firms can change everything — build new factories, enter or exit the industry. The curve is more flat (elastic).
• ·In the short run, the supply curve of a competitive firm is the portion of the $MC$ curve above the $AVC$ (average variable cost) point. If the price is below $AVC$, the firm does not produce; it i...
• ·In the long run, the supply curve is the part of the $MC$ curve above the $ATC$ (average total cost) point. If the price is below $ATC$, the firm incurs losses and exits the industry.
• ·Absolutely inelastic supply: vertical curve. Quantity is fixed regardless of price. Example: land in the city center, unique artwork.
• ·Absolutely elastic supply: horizontal curve. Firms are ready to supply any quantity at the given price. Possible with constant $MC$ and free entry.
• ·“Backward-bending” curve: labor supply may decrease at very high wages (income effect exceeds substitution effect — people prefer leisure).
• ·Pricing power: if supply is inelastic (limited capacity, rare resources), producers have pricing power.
• ·Entry barriers: if supply is easy to expand (low barriers), high profits attract competitors and fall.
• ·Cyclicality: industries with long investment cycles (oil, mining) have inelastic short-term supply — prices are volatile.
• ·Costs: growth of resource prices (oil, metals, labor) shifts the supply curve left — higher prices, lower profits.

• ·If the price is above equilibrium: $Q_s > Q_d$ — surplus
• ·Sellers cannot sell all they want
• ·Competition among sellers → prices fall
• ·The price drops to equilibrium
• ·If the price is below equilibrium: $Q_d > Q_s$ — shortage
• ·Buyers cannot buy all they want
• ·Competition among buyers → willingness to pay more
• ·The price rises to equilibrium
• ·Rightward shift in demand (demand increases):
• ·At the old price: $Q_d > Q_s$ (shortage)
• ·Price rises
• ·Movement along the supply curve: $Q_s$ increases
• ·New equilibrium: higher $P^*$, higher $Q^*$
• ·Leftward shift in demand (demand decreases):
• ·At the old price: $Q_s > Q_d$ (surplus)
• ·Price falls
• ·New equilibrium: lower $P^*$, lower $Q^*$
• ·Rightward shift in supply (supply increases):
• ·At the old price: $Q_s > Q_d$ (surplus)
• ·Price falls
• ·Movement along the demand curve: $Q_d$ increases
• ·New equilibrium: lower $P^*$, higher $Q^*$
• ·Leftward shift in supply (supply decreases):
• ·At the old price: $Q_d > Q_s$ (shortage)
• ·Price rises
• ·New equilibrium: higher $P^*$, lower $Q^*$
• ·Demand and supply both increase:
• ·$Q^*$ definitely increases
• ·$P^*$ is indeterminate: if demand increases more — $P^*$ rises, if supply increases more — $P^*$ falls
• ·Demand increases, supply decreases:
• ·$P^*$ definitely rises
• ·$Q^*$ is indeterminate
• ·Walrasian adjustment: the price instantly reacts to imbalance. An auctioneer announces a price, collects bids, adjusts. Idealized model.
• ·Marshallian adjustment: the quantity adjusts to the price. If the price is above costs, production expands. Slower, more realistic for most markets.
• ·Pareto efficiency: it is impossible to make someone better off without making someone else worse off. In equilibrium all mutually beneficial exchanges have already occurred.
• ·Maximum total surplus: the sum of consumer surplus + producer surplus is maximized at equilibrium.
• ·Any deviation from $P^*$ creates losses (deadweight loss).
• ·Understanding supply and demand allows prediction of price responses to events.
• ·Drought → decline in grain supply → rise in prices.
• ·Economic growth → increased demand for oil → rise in prices.
• ·Equilibrium analysis helps assess whether current prices are stable or changes are expected.
• ·High prices with limited supply may persist.
• ·High prices with easily expandable supply are temporary.
• ·Understanding market equilibrium helps with pricing, assessing competitive dynamics, planning capacity.

Examples of Price Ceilings

• ·Rent control: Maximum rent is set below the market rate
• ·Housing shortage: more people want to rent than there are apartments
• ·Queues, bribes, "connections" to get an apartment
• ·Landlords do not invest in repairs—quality declines
• ·New construction decreases—why build if it’s impossible to get a market return?
• ·Paradox: "affordable housing" policy makes housing less accessible
• ·Food price ceilings: USSR, Venezuela—chronic shortage
• ·Queues, black market, ration cards
• ·Farmers cut production—not profitable
• ·Gasoline price ceilings: USA in the 1970s—long lines at gas stations
• ·Alternative allocation mechanisms: first come, first served; odd/even license plates

Consequences of Price Ceilings

• ·Shortage: the main consequence. $Q_d > Q_s$ at an artificially low price.
• ·Non-price allocation: queues (loss of time), corruption, connections, black market.
• ·Quality reduction: producers cut costs since they can’t raise the price.
• ·Decreased investment: why expand production if you can’t earn profit?
• ·Deadweight loss: some mutually beneficial transactions do not occur. Welfare loss.
• ·Black market: goods are sold illegally above the ceiling. Criminalization of the economy.

Examples of Price Floors

• ·Minimum wage: The price of labor cannot be below a set minimum
• ·If the minimum is above the equilibrium wage—unemployment
• ·$Q_s$ of labor > $Q_d$ of labor: more people want to work than there are jobs
• ·Most vulnerable: youth, unskilled workers
• ·Debate: how large is the unemployment effect? Studies show different results
• ·Agricultural supports:
• ·Minimum prices for grain, milk
• ·Production surplus—the government is forced to buy up the excess
• ·"Butter mountains", "wine lakes" in the EU
• ·Costly for the budget, distorts incentives

Consequences of Price Floors

• ·Surplus: the main consequence. $Q_s > Q_d$ at an artificially high price.
• ·Unemployment (in the labor market): workers want to work, but there are no vacancies.
• ·Budget costs: government is often forced to buy up the surplus (agricultural products).
• ·Inefficiency: resources are directed to overproduction.
• ·Deadweight loss: some transactions do not occur, although they would be mutually beneficial.
• ·Inelastic demand/supply: even substantial controls create only a small imbalance. Quantity changes little.
• ·Elastic demand/supply: even a small control creates a large imbalance. Quantity reacts strongly to a price deviation.
• ·Long-term: in the long run, elasticity is higher—effects of controls intensify over time.
• ·Instead of rent control: rent subsidies, vouchers. Money goes to those in need, market remains free.
• ·Instead of minimum wage: earned income tax credit (tax credit for the working poor). Supports income without causing unemployment.
• ·Instead of price supports in agriculture: direct payments to farmers. Supports their income without distorting the market.
• ·Visible beneficiaries: those who get a cheap apartment or higher wage
• ·Hidden costs: shortages, unemployment, decline in quality—are dispersed, not obvious
• ·Short-term gains vs long-term costs
• ·Simplicity of explanation: “protecting the poor from high prices”

• ·$|PED| > 1$ — elastic demand:
• ·$|PED| < 1$ — inelastic demand:
• ·$|PED| = 1$ — unit elasticity:
• ·$|PED| = 0$ — perfectly inelastic demand:
• ·$|PED| = \infty$ — perfectly elastic demand:
• ·At the upper part of the curve (high price, small quantity): demand is elastic.
• ·At the lower part (low price, large quantity): demand is inelastic.
• ·In the middle: unit elasticity.
• ·Availability of Substitutes:
• ·Share in the Budget:
• ·Necessity vs Luxury:
• ·Market Definition:
• ·Elastic demand ($|PED| > 1$):
• ·Inelastic demand ($|PED| < 1$):
• ·Unit elasticity:
• ·Pricing power: companies with inelastic demand have pricing power—they can raise prices without a substantial loss in sales. This is margin protection in an inflationary environment.
• ·Competitive analysis: demand elasticity for a firm's product depends on industry competitive structure. High competition = high elasticity = price and margin pressure.

• ·XED
  gt; 0$ — substitute goods: an increase in B's price raises demand for A
• ·XED
  lt; 0$ — complementary goods: an increase in B's price lowers demand for A
• ·XED $\approx 0$ — independent goods: No link between demand for A and price of B

Practical significance of XED

• ·Market definition: antitrust authorities use XED to determine market boundaries.
• ·Competitive strategy: understanding substitutes and complements is critical for business. Who are the real competitors? Whose price increases help/hurt?
• ·Complement pricing: classic strategy — low price on the main product, high price on complements (printers and ink, razors and blades).
• ·YED
  gt; 0$ — normal goods: Rising income increases demand
• ·YED
  lt; 0$ — inferior goods: Rising income reduces demand

Classification of normal goods

• ·$0 < \text{YED} < 1$: Demand grows slower than income
• ·YED
  gt; 1$ — luxury goods:

Practical applications of YED

• ·Demand forecasting: in economic growth, demand for luxury rises faster than for the economy as a whole. In recessions — it falls faster.
• ·Sectoral analysis:
• ·Defensive sectors (low YED): food, utilities, healthcare — stable demand during recessions
• ·Cyclical sectors (high YED): automobiles, consumer electronics, tourism — volatile demand
• ·Positioning: companies can choose segments with different YED. Mass market vs. luxury — different sensitivity to economic cycles.

Factors determining PES:

• ·Immediate period: PES $\approx 0$ (fixed stock)
• ·Short run: low PES (limited capacity)
• ·Long run: high PES (new capacity, new firms)
• ·Resource mobility:
• ·Inventories:
• ·Excess capacity:
• ·Rule: the less elastic side bears the greater share of the tax.
• ·If demand is inelastic, supply is elastic: consumers pay most of the tax (producers readily exit).
• ·If supply is inelastic, demand is elastic: producers pay most (consumers readily exit).
• ·Who are the company's competitors?
• ·How does a change in competitors’ prices affect sales?
• ·Which complementary markets are critical?
• ·How cyclical is the company?
• ·How will economic growth/recession affect revenue?
• ·Is this a defensive or growth investment?
• ·How quickly does the industry respond to price changes?
• ·Are high prices sustainable or will supply quickly increase?
• ·Are there barriers to expansion?

Examples of Tax Incidence

• ·Tax on cigarettes:
• ·Demand is inelastic (addiction): |PED| ≈ 0.4
• ·Supply is relatively elastic
• ·Most of the tax falls on smokers
• ·The price rises by almost the full amount of the tax
• ·Tax on luxury yachts (USA, 1990):
• ·Demand is very elastic (easy to forgo buying a yacht)
• ·Supply is relatively inelastic (specialized shipyards)
• ·Sales collapsed, shipyards closed
• ·Tax was repealed — did not generate revenue, destroyed jobs
• ·Tax on labor (payroll tax):
• ·Labor supply is relatively inelastic (people need jobs)
• ·Most of the burden falls on workers, even if the employer remits the payment
• ·This explains why “employer taxes” reduce wages
• ·Some transactions that would be beneficial without the tax do not occur
• ·Buyers willing to pay more than sellers' costs but less than the tax-inclusive price do not buy
• ·Sellers willing to sell for less than the buyer’s price but more than their net-of-tax price do not sell
• ·Subsidy: increases quantity above the efficient level
• ·Goods are produced whose costs exceed their value to consumers
• ·Overpayment for units that are not worth it
• ·Who will actually bear the burden of a new tax?
• ·Companies with inelastic demand can pass the tax on
• ·Companies in competitive industries (elastic demand) cannot
• ·Industries with high DWL — candidates for reform
• ·Subsidized industries — risk of subsidy removal

• ·Airline tickets: business travelers (inelastic demand) pay more, tourists (elastic)—less
• ·Movie theaters: discounts for students and pensioners (more elastic)
• ·Medicines: high prices in wealthy countries, low in poor ones
• ·Software: discounts for education
• ·Low markups
• ·Margin pressure
• ·Importance of costs
• ·High markups
• ·Stable margin
• ·Pricing power
• ·Protection from cost inflation
• ·Econometric methods: regression of price and quantity with control for other factors. Requires data, endogenous variable problem is complex.
• ·Experiments: A/B price tests. Reliable, but limited.
• ·Surveys: conjoint analysis—assessment of willingness to pay. Subjective, but useful for new products.
• ·Sales forecasting with price changes
• ·Modeling competitive scenarios
• ·Assessment of the influence of macro factors (income, resource prices)
• ·Taxes on inelastic goods (cigarettes, alcohol, gasoline) raise a lot of money with minimal DWL
• ·But may be regressive
• ·Short-term supply shocks—strong influence on prices
• ·Long-term high prices—decrease in consumption (peak oil demand)
• ·OPEC can control prices in the short run
• ·How elastic is the demand for its products?
• ·Can the company pass cost increases on to consumers?
• ·How will demand change in a recession (YED)?
• ·What goods are substitutes and complements?
• ·How elastic is industry supply (barriers to entry)?
• ·High demand elasticity + low barriers = price pressure
• ·High YED + cyclical business = volatility
• ·Low PES in the industry + growing demand = windfall profits, but temporary

• ·The first glass of water on a hot day — enormous utility
• ·The second — still good, but less
• ·The fifth — almost indifferent
• ·The tenth — might be unpleasant
• ·TU grows, but more slowly (convex curve)
• ·MU falls with each unit
• ·At some point, MU may become negative (oversaturation)
• ·When $P_x$ falls, $MU_x/P_x$ rises
• ·To restore equality, one must increase consumption of X (reduce $MU_x$)
• ·Hence: lower price — higher consumption — the law of demand
• ·Total utility of water is enormous — without it, one cannot survive
• ·Marginal utility of water is low — water is abundant, an extra liter adds almost nothing
• ·Marginal utility of diamonds is high — diamonds are scarce, each is valuable
• ·People do not always maximize rationally
• ·Context effects, framing, mistakes
• ·One cannot compare “my” and “your” utility
• ·This limits conclusions about redistribution
• ·Tastes change over time
• ·Formation of habits, dependencies

• ·Always negative: price decrease → increase in consumption
• ·Reflects the principle: we buy more of that which has become relatively cheaper
• ·Operates for any goods — normal and inferior
• ·Measurement: how much the consumer would change their purchase if the price changed, but we "compensated" the change in income so that utility remained the same.
• ·Price decrease = increase in real income → more consumption
• ·The income effect is positive (in the same direction as the substitution effect)
• ·Price decrease = increase in real income → less consumption of the inferior good
• ·The income effect is negative (opposite to the substitution effect)
• ·"Imaginary" income at which the consumer reaches the original indifference curve under new prices
• ·More common in theory
• ·"Imaginary" income = cost of the original bundle at new prices
• ·Easier to compute
• ·The good must be inferior (negative income effect)
• ·The income effect must exceed the substitution effect in absolute value
• ·The good must occupy a large proportion of the budget (so that the income effect is significant)
• ·Tax Policy:
• ·Labor Supply:
• ·For the Investor:

• ·Cannot process all information
• ·Use simplified rules (heuristics)
• ·Settle for “good enough,” not seeking the optimum
• ·“90% survival rate” vs “10% mortality” — different treatment choices
• ·“20% discount” vs “Pay 80%” — different perception
• ·“Cash penalty” vs “Card discount” — different reaction
• ·Endowment effect: people value what they own more highly than what they could gain. Willingness to sell > willingness to buy.
• ·Status quo bias: preference for the current state, reluctance to change.
• ·Sunk cost fallacy: continuing losing projects to “justify” past investments.
• ·“Entertainment money” is spent more easily than “savings”
• ·Casino winnings are spent more riskily than salary
• ·Gift cards are used for “pleasures,” not necessities
• ·Prefer $100 today vs $110 tomorrow
• ·But indifferent between $100 in a year and $110 in a year and a day
• ·Inconsistency over time
• ·Procrastination — postponing unpleasant tasks
• ·Insufficient retirement savings
• ·Overeating, smoking — immediate pleasure vs deferred consequences
• ·High “initial” price makes a discount more attractive
• ·First offer in negotiations influences the outcome
• ·Random number influences estimate (classic Tversky-Kahneman experiments)
• ·Framing offers (gain vs avoiding loss)
• ·Anchoring prices
• ·Defaults — right default choice
• ·Scarcity — limited offer creates urgency
• ·Automatic enrollment in retirement programs
• ·Proper framing of health information
• ·Defaults for organ donation
• ·Understanding how companies use behavioral effects
• ·Own mistakes: loss aversion in portfolio management, sunk cost fallacy
• ·Companies with “sticky” products (status quo bias) — competitive advantage

• ·Labor (L): human effort, both physical and intellectual
• ·Capital (K): machines, equipment, buildings, technologies
• ·Land: natural resources, territory
• ·Entrepreneurship: organization and risk-taking
• ·Describes technology—how inputs are transformed into output
• ·Shows the maximum—assumes efficient utilization
• ·Depends on the technological level—technical progress shifts the function
• ·Some factors are fixed (usually capital)
• ·The firm can change only variable factors (labor)
• ·There are fixed costs
• ·All factors are variable
• ·The firm can change scale—build a new plant, shut down an old one
• ·All costs are variable
• ·First workers—high $MPL$ (lots of equipment per person)
• ·More workers—$MPL$ falls (crowding, waiting for machines)
• ·Too many—$MPL$ can become negative (getting in each other’s way)
• ·If $MPL > APL$ → $APL$ increases
• ·If $MPL < APL$ → $APL$ decreases
• ·$MPL = APL$ at the $APL$ maximum point
• ·Stage I: $APL$ rises ($MPL > APL$). Resources underused. Hire more.
• ·Stage II: $APL$ falls, but $MPL$ is positive. Rational range for the firm.
• ·Stage III: $MPL$ is negative. Oversaturation. Need to cut back.
• ·Downward slope: to maintain output with less $L$, more $K$ is needed
• ·Do not intersect
• ·Convex to the origin (diminishing MRTS)
• ·The further from the origin—the greater the output
• ·Growth in $APL$—source of profit growth without increasing costs
• ·Comparing $APL$ across firms—competitive analysis
• ·High—automated production, high fixed costs, operating leverage
• ·Low—labor-intensive production, flexibility, but scale limitations
• ·Shift the production function upward
• ·Companies with R&D and innovation—potential for productivity growth

• ·Explicit payments for resources
• ·Wages, rent, materials, interest
• ·Reflected in financial statements
• ·Accounting costs plus implicit (opportunity) costs
• ·Opportunity cost of all resources used
• ·Include: foregone income from own capital, the owner's time
• ·At a salaried job he could earn $60,000
• ·$100,000 in a bank would bring $5,000 in interest
• ·Do not depend on the volume of production in the short run
• ·Rent, insurance, depreciation, managers' salaries
• ·Exist even with zero output
• ·Depend on the volume of production
• ·Raw materials, electricity, piece-rate labor
• ·With zero output equal zero
• ·At first may fall (specialization, increasing returns)
• ·Then rises (diminishing returns)
• ·MC intersects AVC and ATC at their minimums
• ·If $MC < AVC$ → AVC falls
• ·If $MC > AVC$ → AVC rises
• ·$MC = AVC$ at the minimum of AVC
• ·Envelope of the short-run ATC curves
• ·For each $Q$, the minimally possible AC with the optimal plant size
• ·Economies of scale (LRAC falls)
• ·Constant returns to scale (LRAC is horizontal)
• ·Diseconomies of scale (LRAC rises)
• ·Specialization and division of labor
• ·More efficient equipment with larger volumes
• ·Distribution of fixed costs (R&D, marketing)
• ·Bulk discounts from suppliers
• ·Coordination problems—management complexity
• ·Bureaucratization
• ·Decreased employee motivation
• ·Communication failures
• ·High FC → operational leverage → earnings volatility
• ·High VC → flexibility, but limited margin potential as output increases
• ·Strong → advantage for large players, industry consolidation
• ·Weak → possibility for niche players
• ·High relative to the market → natural oligopoly or monopoly
• ·Low → competitive market with many players

• ·Ray from the origin — fixed factor proportions (homothetic function)
• ·Curved — proportions change with scale
• ·Perfect substitutes:
• ·Perfect complements (Leontief function):
• ·Imperfect substitutes (Cobb-Douglas, others):
• ·$\alpha + \beta = 1$: constant returns to scale
• ·$\alpha + \beta > 1$: increasing returns
• ·$\alpha + \beta < 1$: decreasing returns
• ·Companies able to substitute factors — more adaptive to price changes
• ·Rigid proportions — vulnerable to factor price shocks
• ·Capital-intensive companies — suffer less from rising wages
• ·Labor-intensive — benefit from cheap labor, suffer from labor becoming more expensive

• ·Indivisibility: some equipment requires a minimum scale
• ·Rule of 2/3: volume increases as the cube of size, surface area—as the square.
• ·Specialization: at larger scale—narrower specialization for workers and equipment
• ·Bulk discounts
• ·Bargaining power with suppliers
• ·Access to cheap financing for large companies
• ·Risk diversification
• ·Spreading fixed expenses over larger sales
• ·Product value increases with the number of users
• ·Coordination becomes more complex
• ·Bureaucratization, slow decisions
• ·Loss of entrepreneurial spirit
• ·Weakened connection between results and reward
• ·"Free riding" in large organizations
• ·Distortion of information during transmission
• ·Loss of feedback from customers
• ·Logistics costs
• ·Adaptation to local conditions
• ·High MES relative to market:
• ·Little room for competitors
• ·Natural oligopoly or monopoly
• ·Examples: automobile manufacturing, aviation, microchip production
• ·Many firms can coexist
• ·Competitive market
• ·Examples: restaurants, hair salons, small-scale manufacturing
• ·Shared resources: R&D, marketing, distribution
• ·Complementary products
• ·Use of byproducts
• ·Large players in industries with economies of scale have a competitive advantage
• ·Small players are vulnerable or must seek niches
• ·Industries with strong economies of scale tend to consolidate
• ·M&A—a way to achieve scale
• ·Firms that are too large can suffer from diseconomies
• ·Splitting up, spin-offs can create value
• ·Extreme economies of scale
• ·"Winner takes all"
• ·First to reach scale—sustained advantage

• ·Reflected in financial statements
• ·Basis for taxation
• ·Regulated by standards (GAAP, IFRS)
• ·Does not account for opportunity costs
• ·Foregone income from alternative use of resources
• ·Opportunity cost of the owner's capital
• ·Alternative salary for the entrepreneur
• ·Foregone rental income from own premises
• ·The firm covers all costs, including opportunity
• ·Accounting Profit = Normal Profit = Implicit Costs
• ·No incentive to leave or enter the industry
• ·Supernormal (abnormal) profit
• ·The firm earns more than in alternative uses
• ·Attracts new entrants
• ·Economic losses
• ·Better to use resources otherwise
• ·Exit incentive
• ·Revenue: 5,000,000 rub/year
• ·Explicit costs: 3,500,000 rub (salaries, products, rent, utilities)
• ·Accounting profit: 1,500,000 rub
• ·Implicit costs:
• ·Salary he could earn: 1,200,000 rub
• ·Return on invested capital (alternatively): 300,000 rub
• ·Total implicit: 1,500,000 rub
• ·Economic profit: 1,500,000 − 1,500,000 = 0 rub
• ·Accounting profit can mask economic losses
• ·Positive accounting profit with negative economic profit—a signal to review
• ·Supernormal profits attract competitors
• ·In long-run equilibrium of perfect competition, economic profit = 0
• ·Economic profit takes into account cost of capital
• ·Positive economic profit = value creation (ROIC > WACC)
• ·EVA > 0: company creates value—earns more than the cost of capital.
• ·EVA < 0: destroys value—investors are better off investing elsewhere.
• ·A company can be profitable according to the books, but not create value
• ·Need to compare ROIC with WACC
• ·Supernormal profits are sustainable only with barriers to entry
• ·Without barriers—competition will drive to zero
• ·Cash vs accrual
• ·Operating vs non-operating
• ·Recurring vs one-time

• ·The additional unit brings more than it costs
• ·Profit increases as output rises
• ·One should produce more
• ·The additional unit costs more than it brings
• ·Profit decreases as output rises
• ·One should produce less
• ·The last unit adds exactly as much as it costs
• ·Further change will not improve profit
• ·MC — U-shaped, then increasing
• ·MR — depends on market structure
• ·Perfect competition: MR = P (price is given) → P = MC
• ·Monopoly: MR < P
• ·Monopolistic competition: similar to monopoly
• ·Oligopoly: more complicated due to interdependence, but the principle is the same

Revenue Maximization (Sales Maximization)

• ·Manager salaries and status correlate with size
• ·Market share — indicator of success
• ·Company growth — career opportunities
• ·Output is higher than under profit maximization
• ·Price is lower
• ·Profit is not maximized, but “sufficient”

Growth Maximization

• ·Reinvesting profits (less dividends)
• ·Capturing markets, diversification
• ·M&A activity

Managerial Theories

• ·Expense preferences
• ·Discretionary investments
• ·Bloated staff
• ·Expensive offices, corporate jets
• ·“Empire building”

Satisficing

• ·Optimum search is too expensive
• ·Information is incomplete
• ·Cognitive limitations
• ·Target level of profit, sales, market share

Behavioral Theory of the Firm

• ·Negotiations, compromises
• ·Goals are formed in the process, not set externally
• ·“Organizational slack” — reserves for satisfying all

• ·Signal for entry of new firms
• ·Resources are directed into a profitable industry
• ·Supply increases
• ·Signal for exit
• ·Resources are redirected to more efficient uses
• ·Supply decreases
• ·No incentives to enter or exit
• ·New firms enter
• ·Market supply increases
• ·Market price falls
• ·Profit of existing firms decreases
• ·Process continues until economic profit = 0
• ·Market supply decreases
• ·Market price rises
• ·Losses of those remaining decrease
• ·Process continues until economic profit = 0
• ·High MES (minimum efficient scale) requires large investments
• ·A newcomer must immediately reach scale or bear high costs
• ·Large initial investments
• ·Limited access to financing
• ·Control of key resources (patents, deposits)
• ·Supplier networks, contracts
• ·Reputation, consumer trust
• ·Marketing costs for newcomers
• ·Licenses, permits
• ·Standards, requirements
• ·Value of the product increases with the number of users
• ·It is difficult for a newcomer to compete with an established network
• ·Irrecoverable investments (specific equipment)
• ·Psychologically difficult to "recognize losses"
• ·Long-term contracts with workers, suppliers
• ·Penalties for early termination
• ·Social obligations
• ·Environmental requirements when closing
• ·Presence in the industry for other purposes
• ·"Flagship" product
• ·Competitive markets
• ·Low stable profits
• ·Example: restaurants, retail trade
• ·Sustained high profits
• ·Example: pharmaceuticals, software
• ·Excess capacity, price wars
• ·Unstable low profits
• ·Example: airlines, hotel business
• ·High but volatile profits
• ·Example: heavy industry
• ·Supernormal profits without barriers are temporary
• ·Entry barriers are key to sustainable competitive advantage
• ·"Moat" analysis (defensive moat)
• ·High profits attract — assess threat of new competitors
• ·Disruption from new technologies can circumvent traditional barriers
• ·Industries with high exit barriers — protracted price wars
• ·Consolidation is often necessary to restore profitability

• ·Each possesses a small share of the market
• ·No one can individually influence the price
• ·Atomistic structure
• ·Goods from all sellers are identical
• ·Buyers are indifferent to whom they purchase from
• ·No brands, no differentiation
• ·No barriers for new firms to enter
• ·No barriers to exit
• ·Resources are mobile
• ·All participants know prices, quality, technologies
• ·No information asymmetry
• ·Rational decision-making
• ·Search, negotiation, contracts — all are costless
• ·Instantaneous transactions
• ·Raise the price — would lose all buyers (there are identical alternatives)
• ·Lower the price — makes no sense (will sell any quantity at the market price anyway)
• ·Agricultural markets:
• ·Many farmers
• ·Standardized product (wheat of a certain type)
• ·Relatively free entry
• ·Exchange-based prices
• ·Financial markets:
• ·Many participants
• ·Homogeneous assets (stock of company X)
• ·High liquidity
• ·Transparent information
• ·Retail markets with the Internet:
• ·Ease of price comparison
• ·Standardized goods
• ·Pressure on margins
• ·Benchmark: a standard for comparison with real markets.
• ·Understanding mechanisms: demonstrates how the price mechanism works in pure form.
• ·Efficiency: perfect competition achieves allocative and productive efficiency — a benchmark for assessing deviations.
• ·Predictions: direction of changes when moving closer to or further from competition.
• ·Differentiation: most products are differentiated (brands, quality, service).
• ·Barriers: there are almost always entry barriers (capital, regulation, reputation).
• ·Information: imperfect, asymmetric.
• ·Transaction costs: significant.
• ·Strategic behavior: large players influence the market.

• ·Market price P*
• ·Market quantity Q*
• ·Firms may earn supernormal profits (P > ATC)
• ·Firms may incur losses (P < ATC)
• ·Number of firms is fixed
• ·New firms enter (attracted by profit)
• ·Market supply shifts to the right
• ·Market price falls
• ·Profit decreases
• ·Entry continues until P = ATC
• ·Market supply shifts to the left
• ·Market price rises
• ·Losses decrease
• ·Exit continues until P = ATC
• ·P = MC (profit maximization)
• ·P = ATC (zero economic profit)
• ·P = minimum LRAC (optimal scale)
• ·Economic profit = 0
• ·No incentives for entry or exit
• ·Firms operate at the minimum of average costs
• ·Productive efficiency is achieved
• ·Each firm produces at the minimum ATC
• ·Resources are not wasted
• ·The price paid by consumers equals marginal cost of production
• ·Resources are allocated where they are valued most
• ·No deadweight loss
• ·Short-term: price rises, existing firms receive profit
• ·Long-term: new firms enter, supply increases, price returns to minimum LRAC
• ·Result: more firms, more output, same price (under constant costs)
• ·Short-term: some firms incur losses
• ·Long-term: firms exit, supply decreases, price rises to new minimum ATC
• ·Result: fewer firms, higher price
• ·In competitive industries — tends toward the cost of capital
• ·Supernormal profits are temporary without barriers
• ·Close to perfect competition
• ·Compete on costs
• ·Low margin, high sensitivity to cycles
• ·The Internet brings many markets closer to competition
• ·Price transparency, lower barriers
• ·Pressure on margin for “traditional” players

• ·Industry is a small part of resource markets
• ·Resources are widely available
• ·Increase in demand → in the short run, price rises, profit occurs
• ·Entry of new firms
• ·Costs do not change (resources are cheap)
• ·Price returns to the same minimum LRAC
• ·Industry is a large buyer of specific resources
• ·Resources are limited or have rising extraction costs
• ·Increase in demand → entry of new firms
• ·Demand for resources increases → resource prices rise
• ·Costs of all firms rise → LRAC shifts upward
• ·New equilibrium at a higher price
• ·Economies of scale in supplying industries
• ·Development of infrastructure, learning
• ·Network effects
• ·Increase in demand → entry of new firms
• ·Supplying industries achieve scale → resource prices fall
• ·Costs decrease → LRAC shifts downward
• ·New equilibrium at a lower price
• ·In industries with increasing costs — prices rise with expansion
• ·In industries with decreasing costs — prices fall (technology, electronics)
• ·The type of industry determines long-term price dynamics
• ·Commodity: prices reflect the costs of the marginal producer
• ·Technology: expect prices to fall as the market grows
• ·Increasing-cost: advantage for low-cost producers
• ·Decreasing-cost: early leaders can secure an advantage
• ·Constant-cost: competition on efficiency, low margins
• ·Inframarginal producers: those whose costs are below the market price. Receive rent (producer surplus).
• ·Marginal producer: one whose costs equal the market price. Zero economic profit.
• ·Best resources (fertile land, rich field)
• ·Best technologies

• ·Shifts the supply curve upward by the amount of the tax
• ·Price to consumers rises (but by less than the tax)
• ·Price to producers falls
• ·Quantity decreases
• ·Burden is distributed according to elasticity
• ·Some transactions do not occur
• ·Loss of welfare—a triangle between the curves
• ·Shifts supply downward
• ·Price falls, quantity increases
• ·Benefits are distributed according to elasticity
• ·Budgetary expenditure
• ·Deadweight loss from overproduction
• ·Resource distortion
• ·World price lower than domestic → imports
• ·Consumers benefit (lower prices)
• ·Producers lose (competition)
• ·Net gain for the country
• ·Raise domestic price
• ·Protect domestic producers
• ·Harm consumers
• ·Create deadweight loss
• ·If above equilibrium—surplus of labor (unemployment)
• ·Employers hire less
• ·Workers are willing to work more
• ·Gap = unemployment
• ·Labor markets are not always competitive
• ·With monopsony, minimum wage may increase employment
• ·Government sets minimum price
• ·Buys surplus
• ·Costs to the budget
• ·Overproduction
• ·Limit supply
• ·Support price
• ·Create rent for quota holders
• ·Internalizes externality
• ·Increases costs for polluting production
• ·Reduces pollution to efficient level
• ·Limits total emissions
• ·Tradable permits
• ·Market price of permit = marginal cost of reduction
• ·Commodities (oil, metals, grain)
• ·Standardized products
• ·Low entry barriers
• ·Many participants
• ·Low-cost producer = competitive advantage
• ·Limited pricing power
• ·Profit depends on costs and cycle
• ·Consolidation can create value
• ·Differentiated products (brands)
• ·High entry barriers
• ·Few large players
• ·Network effects

• ·Pure monopoly—one seller, no substitutes
• ·Dominant firm—one large player, small competitors
• ·Oligopoly—several large players
• ·Monopolistic competition—many sellers, differentiated products
• ·Patents—temporary (expire)
• ·Network effects—can be sustainable, but vulnerable to disruption
• ·Natural monopoly—sustainable, but often regulated
• ·Resource control—depends on alternatives
• ·What protects the company’s profit?
• ·How durable is the barrier?
• ·What threats (technology, regulation)?

• ·Find $Q^*$ where $MR = MC$
• ·Determine price $P^*$ from the demand curve at $Q^*$
• ·Profit = $(P^* - ATC) \times Q^*$
• ·At $|\text{PED}| = 1$: $MR = 0$
• ·At $|\text{PED}| > 1$ (elastic): $MR > 0$
• ·At $|\text{PED}| < 1$ (inelastic): $MR < 0$
• ·$L = 0$: perfect competition ($P = MC$)
• ·$L > 0$: monopoly markup
• ·Competition: $P = MC$, $Q = Q_c$ (efficient quantity)
• ·Monopoly: $P > MC$, $Q = Q_m$
• ·Consumer surplus is reduced
• ·Part shifts to the monopolist (profit)
• ·Part is lost irretrievably (DWL)
• ·Lobbying for regulatory protection
• ·Legal costs to defend patents
• ·Blocking entry of competitors
• ·High margin, stable cash flow
• ·Premium valuation — if power is sustainable
• ·Regulatory intervention
• ·Antitrust lawsuits
• ·Disruption from new technologies
• ·Public pressure
• ·Source of power and its sustainability
• ·Pricing policy — does the company extract maximum?
• ·Regulatory environment — what are the limitations?

• ·Each buyer receives their own price equal to their willingness to pay.
• ·Extraction of all consumer surplus.
• ·Ideally efficient (no DWL) — quantity equals competitive level.
• ·Practically impossible — requires knowledge of individual preferences.
• ·Approximation: auctions, individual negotiations.
• ·Price depends on the quantity purchased.
• ·Self-selection — buyers choose their own “package.”
• ·Examples: wholesale discounts, “the more, the cheaper” tariffs.
• ·Block pricing, two-part tariffs.
• ·Different prices for identifiable groups.
• ·Groups differ in demand elasticity.
• ·Examples: student discounts, children's tickets, prices for different countries.
• ·Most widespread form.
• ·Airline tickets: Business class vs economy.
• ·Advance purchase discounts.
• ·Saturday night stay requirement.
• ·Dynamic pricing.
• ·Pharmaceuticals: High prices in wealthy countries, low in poor (differential pricing).
• ·Software: Student licenses.
• ·Enterprise vs personal.
• ·Freemium models.
• ·Cinemas: Discounts for students, seniors.
• ·Morning showings are cheaper.
• ·Club memberships + service fees.
• ·Amusement parks: entrance + rides.
• ·Telephone service: subscription fee + per-minute charge.
• ·Variable part = MC (efficient quantity).
• ·Fixed part = consumer surplus at P = MC.
• ·Full extraction of CS.
• ·Negative correlation of values: those who highly value A, value B low, and vice versa.
• ·Reduces dispersion in willingness to pay.
• ·First degree: efficient (no DWL), but all surplus goes to seller.
• ·Third degree: May increase or decrease overall welfare.
• ·If opens new markets (previously unserved) — positive.
• ·If simply redistributes — ambiguous.
• ·Companies with effective discrimination extract more profit.
• ·Data and analytics allow better segmentation.
• ·Many pricing plans.
• ·Price personalization.
• ·Geographic pricing.
• ·Dynamic pricing (surge pricing).
• ·Regulatory attention.
• ·Consumer backlash.
• ·Arbitrage (parallel imports).

• ·Prevention of abuse of market power
• ·Protection of competition
• ·Efficiency and innovation
• ·Prohibition of cartels: collusion on prices, division of markets
• ·Merger control: blocking deals that create excessive concentration
• ·Prohibition of abuses: predatory pricing, exclusive contracts
• ·Forced breakup: splitting up monopolies (rarely)
• ·Standard Oil (breakup, 1911)
• ·AT&T (breakup, 1984)
• ·Microsoft (lawsuit, 2000s)
• ·Google, Facebook (modern lawsuits)
• ·State ownership: traditionally for utility services
• ·Private monopoly with price regulation: rate-of-return regulation, price caps
• ·Franchise bidding: competition for the right to be the monopolist
• ·Achieves allocative efficiency
• ·Problem: with natural monopoly, $MC < AC$
• ·Requires subsidies
• ·Firm is break-even
• ·Does not achieve efficiency ($P > MC$)
• ·Compromise between efficiency and financial sustainability
• ·The regulator sets an acceptable rate of return on capital
• ·Problem: Averch-Johnson effect — incentive for excessive capital
• ·Complexity: defining a “reasonable” rate, assessing capital
• ·Price can rise no faster than inflation minus efficiency factor
• ·Stimulates cost reduction (the firm keeps the savings)
• ·Used in the UK and other countries
• ·Technological changes reduce the naturalness of monopoly
• ·Regulation creates inefficiencies and regulatory capture
• ·Competition stimulates innovation
• ·Aviation (USA, 1978)
• ·Telecommunications
• ·Electricity (splitting into generation/transmission/distribution)
• ·Network effects
• ·Platform business models
• ·Data as an asset
• ·Zero marginal costs
• ·Are traditional approaches applicable?
• ·How to measure market power when prices are zero (Google, Facebook)?
• ·How to account for innovation dynamics?
• ·Big Tech breakup
• ·Data portability
• ·Interoperability requirements
• ·Platform regulation
• ·Companies with market power are under scrutiny
• ·Antitrust lawsuits — material risk
• ·Price regulation — limits upside
• ·What regulation is the company subject to?
• ·What is the probability of tightening?
• ·How does regulation affect margin?
• ·Stable cash flows
• ·Limited growth
• ·Dividend plays

• ·Each firm has a small market share
• ·The decisions of one have little effect on others
• ·No strategic interdependence
• ·Products are similar, but not identical
• ·Differences: quality, design, location, brand, service
• ·Each firm is a "monopolist" of its own variety
• ·No significant barriers
• ·New firms can create a similar product
• ·Downward-sloping demand: thanks to differentiation, the firm is not a price taker. Reducing the price increases sales, but not indefinitely.
• ·Profit maximization: $MR = MC$, as in monopoly.
• ·Market power: is limited by the presence of substitutes. The more substitutes and the closer they are — the more elastic the demand.
• ·If $P > ATC$: the firm earns a profit.
• ·If $P < ATC$: the firm makes a loss, but continues if $P > AVC$.
• ·In the short run, both profit and loss are possible — depends on the positions of the curves.
• ·Free entry: if profit is positive — new firms enter with their differentiated products.
• ·Entry effect:
• ·Demand for each firm's product shifts left (market share taken away)
• ·Demand becomes more elastic (more substitutes)
• ·Entry continues until: $P = ATC$, economic profit $= 0$.
• ·$MR = MC$ (profit maximization)
• ·$P = ATC$ (zero economic profit)
• ·The demand curve touches ATC (does not cross)
• ·Output is not at minimum cost
• ·"Loss" of productive efficiency
• ·More firms, less output for each
• ·Advertising: creating brand awareness, loyalty
• ·Quality: improving the product
• ·Service: additional services
• ·Design: aesthetic differentiation
• ·Innovation: new product variants
• ·Many small players
• ·Low entry barriers
• ·Differentiation — but imitable
• ·Normal profit in the long term
• ·Building a brand as a barrier
• ·Cutting costs
• ·Consolidation can create value

• ·Usually 2–10 major players
• ·Each holds a significant market share
• ·Actions of one affect the others
• ·Firms take into account the reaction of competitors
• ·"If I lower my price—what will they do?"
• ·Game theory is an analytical tool
• ·Substantial—otherwise, there would be more firms
• ·Economies of scale, capital, brands
• ·Homogeneous: oil, steel, aluminum
• ·Differentiated: automobiles, air transportation
• ·Automobiles: Toyota, VW, GM, Ford, Honda...
• ·Telecom: 3–4 operators in most countries
• ·Aviation: several major carriers
• ·Oil: ExxonMobil, Shell, Chevron, BP...
• ·Tech: Apple, Google, Microsoft, Amazon
• ·Banks: a few systemically important institutions
• ·Firms compete on quantity
• ·Each chooses its output, taking rivals’ quantities as given
• ·Nash equilibrium: no one wants to change their choice
• ·Result: between monopoly and competition
• ·Firms compete on price
• ·With a homogeneous product: price falls to MC
• ·"Bertrand paradox": even two firms = competitive outcome
• ·With differentiated products: prices are above MC
• ·Leader-follower
• ·Leader chooses first, knowing the reaction of the follower
• ·Leader gains an advantage
• ·Idea: firms do not react to a competitor’s price increase (their customers leave), but do react to a price decrease (so as not to lose their own).
• ·The demand curve "kinks" at the current point
• ·MR has a discontinuity
• ·Price remains stable even as costs change
• ·Explains: price rigidity in oligopolies.
• ·Criticism: does not explain how the initial price was set.
• ·High barriers protect profits
• ·Price discipline (if pricing wars do not occur)
• ·Stable competitive structure
• ·Price wars can destroy margins
• ·Antitrust regulation
• ·Disruption from new technologies

• ·Game: A situation of strategic interaction with defined players, strategies, and payoffs.
• ·Players: Participants making decisions (firms, countries, individuals).
• ·Strategies: The available courses of action.
• ·Payoffs: The outcomes (profit, utility) for each combination of strategies.
• ·Payoff matrix: A table showing payoffs for all combinations.
• ·For each player, the dominant strategy is to confess.
• ·Result: both confess (-5, -5).
• ·But if both stayed silent, it would be better (-1, -1).
• ·Individual rationality leads to a collectively worse outcome.
• ·Stability—no one deviates unilaterally.
• ·Not necessarily efficient.
• ·There can be multiple Nash equilibria.

Pricing:

• ·Mutually high prices are the best collective outcome (100, 100).
• ·But for each player, the dominant strategy is to lower the price.
• ·Nash equilibrium: (low, low) = (50, 50).
• ·Price wars are the result of this logic.
• ·Cooperation is possible based on the threat of punishment.
• ·Tit-for-tat: start with cooperation, then copy the opponent’s actions.
• ·Reputation and trust become important.
• ·Infinite horizon (or indefinite end).
• ·A sufficiently low discount rate (future is valued).
• ·Ability to observe and punish.
• ·Cartel: explicit collusion to maintain high prices.
• ·Stability problem: Each participant has an incentive to “cheat”—lower the price and take market share.
• ·Prisoner's dilemma—a cartel is unstable.
• ·Small number of participants (easier to coordinate).
• ·Homogeneous product (easier monitoring).
• ·Stable demand.
• ·Punishment for deviation (OPEC).
• ·Temptation to cheat.
• ·Changing conditions.
• ·Entry of new players.
• ·Antitrust prosecution.
• ·Probability of price wars.
• ·Sustainability of price discipline.
• ·Strategic decisions of companies.
• ·History of price discipline.
• ·Non-price competition.
• ·Price setting transparency.
• ·Market leader as a “price umbrella”.
• ·Excess capacity.
• ·New aggressive players.
• ·Lowering of entry barriers.
• ·Commodity-like nature of the product.

• ·Birth: innovation, many small players
• ·Growth: consolidation, the strongest survive
• ·Maturity: oligopoly, stable shares
• ·Decline/transformation: disruption, new cycle
• ·Economies of scale
• ·Network effects
• ·Access to capital
• ·M&A activity
• ·Technological change
• ·Deregulation
• ·New business models
• ·Antitrust intervention

Horizontal mergers: combining competitors.

• ·Synergies: economies of scale, elimination of duplication
• ·Increase in market power
• ·Antitrust oversight

Vertical mergers: combining supplier and buyer.

• ·Elimination of transaction costs
• ·Potential restriction of competition

Conglomerate mergers: combining in different industries.

• ·Diversification
• ·Fewer antitrust issues
• ·Merger control:
• ·Assessment of impact on competition (HHI index)
• ·Blocking or conditions (asset sales)
• ·Examples: AT&T/T-Mobile (blocked), Disney/Fox (conditions)
• ·Cartel prosecution:
• ·Cartels — serious violation
• ·Leniency programs — mitigation for first confessor
• ·Large fines
• ·Abuse of dominance:
• ·Predatory pricing
• ·Exclusive contracts
• ·Tying (bundling products)
• ·Concentration Ratio (CR4, CR8): sum of shares of the 4 or 8 largest firms.
• ·Herfindahl-Hirschman Index (HHI): sum of squares of shares of all firms.
• ·$HHI < 1500$: low concentration
• ·$HHI > 2500$: high concentration
• ·Change in HHI after merger: if $\Delta HHI > 200$ in highly concentrated market — increased regulatory scrutiny.
• ·Chicago School:
• ·Markets self-correct
• ·Concentration is the result of efficiency
• ·Regulation creates costs
• ·Focus on consumer prices
• ·New Brandeis Movement:
• ·Big companies are a problem in themselves
• ·Market power harms democracy
• ·Need for a tougher approach
• ·Relevant for Big Tech
• ·Analysis of competitive dynamics:
• ·Stage of industry life cycle
• ·Consolidation trends
• ·Disruption threats
• ·M&A as a catalyst:
• ·Consolidators may create value
• ·Targets receive a premium
• ·Antitrust risks
• ·Regulatory environment:
• ·Jurisdiction matters (USA vs EU)
• ·Political cycle influences enforcement
• ·Sectoral regulation (tech, finance)

• ·Demand for programmers depends on the demand for software
• ·Demand for oil depends on the demand for transportation services
• ·Demand for builders depends on the demand for housing
• ·Product price: higher P → higher MRP → greater demand for labor
• ·Productivity: higher MP → higher MRP
• ·Price of other factors: if capital becomes more expensive, demand for labor may rise (substitution) or fall (scale effect)
• ·Technology: may increase or decrease demand for labor

• ·Substitution effect: leisure becomes more expensive → we work more.
• ·Income effect: richer → can afford more leisure → we work less.
• ·Employment falls ($L_d$)
• ·Unemployment: $L_s - L_d$
• ·Those who keep their jobs—winners
• ·Those who lose their jobs—losers
• ·The firm is a wage setter, not a wage taker
• ·To hire more, must raise wages for all
• ·Marginal cost of labor
  gt;$ $w$

• ·Fixed supply: land cannot be produced. The quantity is limited.
• ·Supply curve: vertical (absolutely inelastic).
• ·Consequence: the price of land is completely determined by demand.
• ·David Ricardo: rent is the payment for the use of the "original and indestructible powers of the soil."
• ·Differential rent:
• ·Different plots have different fertility.
• ·Marginal land (the worst used) determines the product price.
• ·The best plots receive rent equal to the difference in productivity.
• ·General concept: income above the minimum necessary to keep the resource in its current use.
• ·$ \text{Economic Rent} = \text{Actual Payment} - \text{Opportunity Cost} $
• ·High salaries of sports stars (their alternative is an ordinary job)
• ·Premium for rare skills
• ·Income from patents
• ·Quasi-rent: rent in the short term for specific assets.
• ·Example: a plant built for a particular client. In the short term, it cannot be repurposed.
• ·Any income above variable costs is quasi-rent.
• ·Rent-seeking: activities aimed at obtaining rent without creating value.
• ·Lobbying for protection from competition
• ·Obtaining exclusive licenses
• ·Lawsuits to block competitors
• ·Social costs: resources are spent on redistribution, not on value creation.
• ·Rent as a source of profit:
• ·Companies with unique assets (brands, patents, resources) receive rent.
• ·Rent is more sustainable than competitive profit.
• ·Analysis of sources of rent:
• ·Natural resources
• ·Intellectual property
• ·Regulatory advantages
• ·Network effects

• ·In the short run: PS = profit + fixed costs
• ·In the long run: PS ≈ profit

• ·Wedge between buyer and seller price
• ·Some transactions do not occur
• ·DWL = ½ × t × ΔQ
• ·$P > MC \to Q$
• ·Transactions profitable at $P = MC$ do not occur
• ·Price ceiling below equilibrium → shortage, DWL
• ·Price floor above equilibrium → surplus, DWL
• ·$Q >$ efficient
• ·Units are produced whose costs exceed value
• ·Many small taxes are better than one large one
• ·A broad tax base with low rates is more efficient
• ·The government receives revenue
• ·But CS + PS falls by more than the government receives — the difference = DWL

• ·Perfect competition
• ·Complete markets (no externalities, no public goods)
• ·Perfect information
• ·Absence of transaction costs
• ·Efficiency ≠ fairness
• ·The conditions are rarely fully met
• ·Efficiency and distribution can be separated
• ·First redistribute, then let the market operate
• ·The market is efficient for any "fair" initial distribution
• ·Redistribution creates its own distortions
• ·Information problems
• ·Political economy of redistribution
• ·Market power: $P \neq MC$
• ·Externalities: not all costs/benefits in the price
• ·Public goods: non-excludability, non-rivalry
• ·Information asymmetry: adverse selection, moral hazard

• ·Change in CS
• ·Change in PS
• ·Change in government revenues
• ·Direct expenditures
• ·Opportunity costs
• ·Domestic price rises
• ·CS falls (consumers pay more)
• ·PS rises (domestic producers receive more)
• ·Government receives tariff revenues
• ·DWL: from reduced consumption + from inefficient production
• ·CV: how much needs to be compensated after the change
• ·EV: how much one is willing to pay to avoid the change
• ·Dynamics and long-term effects
• ·Uncertainty
• ·Behavioral effects

• ·Intervention is not always necessary
• ·Clearly defining rights is important
• ·In practice, transaction costs get in the way

• ·Non-rival: consumption by one person does not reduce availability for others.
• ·Non-excludable: it is impossible to exclude non-payers.
• ·National defense
• ·Street lighting
• ·Fundamental science
• ·Private goods: apple, car — the market works.
• ·Club goods: cable TV, swimming pool — can be excluded, but no rivalry.
• ·Common resources: fish in the ocean — "tragedy of the commons".
• ·Public goods: defense — requires government provision.
• ·Determining the optimal level
• ·Political distortions
• ·Inefficiency of government production
• ·Government expenditures: understanding government spending structure — which industries are beneficiaries.
• ·Infrastructure: often a public good — government financing.
• ·Privatization: some “public” services can be privatized with proper design.

• ·Sellers know the quality of the cars, buyers do not
• ·Buyers offer the average price
• ·Owners of good cars leave the market
• ·Only "lemons" remain — the market may collapse
• ·Insurance: the sick buy more
• ·Loans: risky borrowers seek credit more actively
• ·Insurance: the insured person becomes less cautious
• ·Managers: they risk shareholders’ money
• ·Banks: "too big to fail" — know that they will be bailed out
• ·Shareholders vs managers
• ·Patients vs doctors
• ·Clients vs financial advisors

• ·Time and attention
• ·Computational abilities
• ·Information
• ·Availability heuristic: assessment of probability based on how easily examples come to mind. Overestimation of vivid, recent events.
• ·Representativeness: assessment of probability based on similarity to a typical example. Ignoring base rates.
• ·Anchoring: dependence on initial information. The first number influences the estimate.
• ·Overconfidence: overestimation of one's own knowledge and abilities.
• ·Hindsight bias: “I knew this beforehand”—after the fact.
• ·Confirmation bias: seeking confirmation for one's own beliefs.

• ·On the horizontal axis: cumulative % of the population (from the poorest to the richest)
• ·On the vertical axis: cumulative % of income
• ·Scandinavia: 0.25–0.30
• ·South Africa: ~0.63
• ·Russia: ~0.37
• ·Decile/Quintile ratios: the ratio of incomes in the top groups to those in the bottom groups.
• ·Palma ratio: income of the top 10% / income of the bottom 40%.
• ·Top income shares: the share of the top 1%, 0.1% — especially useful for analyzing extreme inequality.
• ·Consumer markets: inequality affects the structure of consumption — luxury vs mass market.
• ·Political risk: high inequality is a potential source of instability.
• ·Policy implications: inequality may lead to redistributive policy.

• ·Access to education
• ·Neighbourhood effects
• ·Social capital

• ·Inelastic demand
• ·Differentiation
• ·High switching costs
• ·Network effects
• ·Limited substitutes