EC 591: Applications of Advanced Microeconomics or

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EC 591 Applications of Advanced
Microeconomicsor

• ECONOMICS OF INDUSTRIAL ORGANIZATION AND
  REGULATION

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Syllabus

• http//web.pdx.edu/7Ecrpk/

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Course Outline and Key Activities

• Grading
• Mid-term 20
• Presentation 15
• Paper 25
• Final 40(Tuesday, March 20 1015 a.m.
  1205 p.m.)

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Mid-term and Final Exams

• a set of study questions will be distributed 1
  week prior to the exam and a subset of those
  questions will appear on the exam

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Presentation/Paper
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Broad Outline of Course

• The first and larger part of the course examines
  the behavior and performance of
  firms/industries/markets that deviate from the
  standard perfectly competitive or monopolistic
  characterizations
• The second part of the course (including YOUR
  contributions via presentations) deals with the
  rationale for regulation, alternative regulatory
  designs, and the performance of
  firms/industries/markets that have been subject
  to regulation

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What is Industrial Organization (IO)?

• concerned with the functioning of imperfectly
  competitive markets and the behavior of firms in
  these markets

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Stylized Facts

• many industries are composed of just a few firms
  - not as many as assumed in the perfectly
  competitive model, and not just one, as assumed
  in the monopoly model
• firms in some industries produce homogeneous or
  almost identical products, whereas firms in other
  industries sell differentiated products
• firms incur high costs in addition to the cost of
  producing the product itself e.g., advertising,
  quality control, product differentiation costs,
  marketing and dealership costs - our standard
  models consider only costs of production

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Objectives of IO Discipline

• Why are markets organized or structured as they
  are?
• How does the manner in which markets are
  organized affect the way in which firms behave
  and markets perform?
• 3. How does the behavior of firms influence the
  structure and performance of markets?

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How do we Describe Market Structure?

• seller concentration - the number and size
  distribution of firms
• why are there are large number of small firms
  that sell hair cuts, jewelry, etc.? - why are
  there only 16 firms in the world who sell cars,
  and why are 5 or 6 of these firms so large?
• boundaries of a firm - degree of vertical
  integration - occurs when a number of sequential
  production stages are organized within a single
  firm instead of each stage corresponding to a
  separate firm
• e.g., some grocery chains have their own milk
  processing plants
• conditions of entry - ease or difficulty with
  which new firms can enter the market
• issue is when is it possible for existing firms
  to earn economic profits without attracting
  entry?
• extent of product differentiation - exists when
  products produced by different firms are not
  viewed as perfect substitutes by consumers

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Identifying the Ideal Allocation

• in order to measure the performance of the market
  (i.e., to determine whether or not the market is
  doing a good job), we need a benchmark for
  purposes of comparing the actual outcome to the
  ideal outcome
• this ideal outcome is attained if our resources
  (inputs to production) all flow to the production
  of the highest valued goods and services and the
  final goods and services produced are all
  purchased by the consumers who most value them
• the optimal or best possible outcome is that
  which maximizes Net Social Benefits (NSB), the
  excess of social benefits received over social
  costs incurred

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Social Cost Benefit Analysis

• Our standard way to gauge the performance of an
  industry is to determine how close the industry
  gets to maximized net social benefits (NSB)
• Similarly, in evaluating the implications of
  regulations, or comparing alternative regulatory
  designs, we do so on the basis of a NSB
  comparison across alternatives

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Static Efficiency I
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Static Efficiency II
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Social Cost Benefit Analysis Dynamic Efficiency

• Where
• T life of project
• Bt project benefits at time t
• Ct project costs at time t
• r social discount rate

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First-Order Condition for Dynamic Efficiency

• Where
• MNSBi marginal net social benefit accruing in
  period i
• MNSB MSB MSC marginal social benefit minus
  marginal social cost

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Assumptions of Perfect Competition

• Producers have similar, non-increasing returns to
  scale technologies
• economies of scale are small relative to the size
  of the market
• average cost increases rapidly beyond a small
  level of production - this implies that there
  will be a large number of sellers, each producing
  a small level of output
• homogenous output
• perfect information - firms know their production
  possibilities consumers know their alternatives
• no barriers to exit or entry
• Consumers maximize utility subject to a budget
  constraint
• Producers maximize profits subject to available
  production possibilities

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Properties of Perfectly Competitive Equilibrium

• Pareto efficiency exists when it is not
  possible to improve one individuals well-being
  without reducing the welfare of another or others
• Price MC ? MSB MSC ????
• No supernormal profits ? P AC

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Short Run Equilibrium under Perfect Competition

• There are 100 perfectly competitive firms in an
  industry each with the following TC function
  
• Marginal cost for each firm is first derivative
  of Total Cost Function

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• Firms supply curve
• Market Supply Curve

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• Suppose market demand curve given by
• Equilibrium

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• each firm produces where P MC q 145
• TR per firm 3(145) 435
• TC per firm 100 1452/100 14.5 324.75
• profit 110.25

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Long Run Equilibrium under Perfect Competition

• In the long run firms will enter until each firm
  earns zero profit
• P MC ATC or dATC/dq 0
• MC ATC

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• Quantity demanded at 2.10 is
• 19000 1500(2.10) 15,850
• Long-run equilibrium number of firms
• NLR QLR/qLR 15,850/100 158.5 firms
• firms supply curve q 50P 5
• Long-run market supply curve QS 158.5q
  158.5(50P 5)
• QS 7925P 792.5

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Welfare Economics Measures

• Consumer Surplus
• 83,767.25
• Producer Surplus
• 15,850
• Net Social Benefits
• 83,767.25