Intermediate Price Theory

Topic Outline and Learning Outcomes

Under each major heading is a list of concepts that will be covered. Assignments are made throughout - PR refers to your textbook. To perform well in this course you need to be able to explain and use each concept mentioned. I have included specific learning outcomes for each section under "Be able to: ..."

__Markets and Prices
__

__Review Links - These are developed for a Principles Class
but provide a good review here__

Deductive vs. Inductive Reasoning

Things are the way they are for a reason

** Read:** PR Chapter 1

** Major Topics:**Positive Analysis

Normative Analysis

Markets

Market Price

Relative Prices

Property Rights

Transactions Costs

Hypotheses and Theories

Inductive and deductive theories

Nominal Price

Real Price

The CPI - Consumer Price Index

** Be able to:** Explain the differences between positive and normative analysis

Explain the concept of relative price

Explain how and why market economy's require property rights

Explain how scientific theories are accepted or rejected

Explain the relationship between real and nominal prices

Convert nominal prices to real prices and vice versa

** Read:** PR Chapter 2.1, 2.2, 2.3

** Major Topics:**Market equilibria

Shortages and Surpluses

Dependent vs. Independent Variables

Supply shift parameters

Demand shift parameters

Taxation

** Be able to:** Explain how market price is determined

Show and explain the effects of shortages and surpluses

Explain dependent and independent variables in terms of the demand and supply curves

List and use the major shift parameters for the demand curve

List and use the major shift parameters for the supply curve

Explain the effects of a tax on a market using consumer and producer surplus analysis

** A Brief Review of Basic Mathematics** Multiply and divide fractions

Be able to:

Calculate and explain slope

Interpret and use linear functions

** Elasticity** - Take good class notes --
your textbook is weak in this area

** Read:** PR Chapter 2.4 & pages 117-123

Price Elasticity or

Point elasticity

Arc elasticity

Major determinants of Price Elasticity

Changes in Total Revenue and the

Cross-Price Elasticity or

** Read:** PR 2.5, 2.6, 2.7

Short-run vs. long-run elasticity

An algebraic treatment of equilibrium

Price Controls

** Be able to:** Interpret the calculated value of an elasticity

Explain the difference between point and arc elasticity's

Calculate point and arc elasticity's

Explain the effects of price elasticity on the total revenues of the firm

Calculate and interpret income elasticity's

Calculate and interpret cross elasticity's

Discuss the differences between SR and LR elasticity's

Solve for equilibrium quantity and price given a linear supply and demand curve

Understand and explain the effects of price ceilings

Understand and explain the effects of price floors

*Demand Theory*

** Read:** PR 3.1

** Major Topics:**Assumptions: completeness, transitivity, more is preferred to less

Indifference Maps

Cardinal vs. Ordinal Rankings

The Marginal Rate of Substitution of X for Y (

Preferences and the shapes of indifference curves

Strong preferences, neuter preferences, economic bads

Perfect and close substitutes

Perfect and close complements

Utility functions

** Read:** PR 3.2 through 3.5

** Major Topics:**The Budget Constraint (BC)

Intercepts and slope Y = P

Manipulating the BC: changes in prices and income

Consumer Choice: Maximizing Consumer Satisfaction (equilibrium using I-curves and BCs)

Corner Solutions

Revealed Preference

Marginal Utiltiy and Consumer Choice (Handout #3)

The Composite Commodity Theorem

Utility Theory, Marginal Utility and Consumer Choice

The Law of Diminishing Marginal Utility

Advantages of the I-Curve approach

** Examples of I-Curve analysis:**Quantity discounts and a kinked budget constraint

Altruism

Food Stamps

Cash Payments vs. Fringe Benefits

Free Housing vs. Housing subsidy

Non-Wage income (work-leisure model)

** Be able to:** Explain the assumptions behind the indifference curve

Explain why ordinal measures are used rather than cardinal preferences

Use indifference curves to reflect the preferences of an individual

Determine the

Explain revealed preference and its implications

Use the composite commodity theorem to explain why money price is on the vertical axis

Explain the relationship of utility theory to prices and the

Apply I-curves to reflect information in a word problem

** Read: **PR 4.1

** Major Topics:**Price-Consumption Curves (PCC)

Deriving the demand curve

Income-Consumption Curves (ICC)|

Normal and inferior goods

Engel Curves

** Be able to:** Derive the individual's demand curve from her PCC

Derive the individual's engel curve from her ICC

Explain the terminolgy used in these concepts

** Read:** PR 4.2

** Major Topics:**Income and Substitution Effects for normal, inferior, and giffen goods

** Be able to:** Delineate between the income and substitution effects for a price
increase and a price decrease

Show the income and substitution effects for a normal good

Show the income and substitution effects for an inferior good

Show the income and substitution effects for a giffen good

** Read:** PR 4.3

** Major Topics:**Market Demand

** Read:** PR 4.4

** Major Topics:**Consumer surplus (CS)

Adam Smith and the Diamond-Water paradox

** Read:** PR 4.5

** Major Topics:**Interdependent Demand Curves

The Bandwagon Effect

The Snob Effect

** Be able to:** Explain how market demand curves are derived

Explain and use consumer surplus

Explain the Bandwagon effect

Explain the Snob effect

__PRODUCTION, COSTS, PROFIT MAXIMIZATION, AND COMPETITIVE SUPPLY__

__PRODUCTION__

** Read:** PR 6.1 & 6.2

** Major Topics:**Describing technology: the production function

Isoquants and isoquant maps

Short-run vs. long-run production: fixed vs. variable inputs

** Read:** PR 6.3

** Major Topics:**Production in the Short-run

A short-run production function (at least one fixed input)

The graphical representation of the production function - the Total Product (TP) function

The Average Product of Labor (APL)

The Marginal Product of Labor (MPL)

Relationships among the APL and the MPL

The law of diminishing marginal returns and the SR

** Read: **PR 6.4

** Major Topics:**Production in the Long-run

A long-run production function (no fixed inputs)

The Marginal Rate of Technical Substitution - MRTS

Using isoquants and isocost curves

** Read:** PR 6.5

** Major Topics:**Returns to Scale

Increasing, decreasing, and constant returns to scale

** Be able to:** Explain the information required for a simple SR production function

Draw a SR production function. What variables are on the axes?

Determine the APL and MPL from TP information

Explain the relationship between the MPL and the APL

Define the Law of diminishing marginal returns (LDMRs)

Explain the effect of the LDMRs on the shape of the SR production curves

Clearly delineate the difference between the SR and the LR production function

Calculate the MRTSKL

Explain substitution among inputs including how and why these substitutions occur

Explain what is meant by a declining or diminishing MRTS. Why would this occur in the SR but not in the LR?

Define and briefly explain types of returns to scale

Use isoquants to show returns to scale

__COSTS__

** Read:**PR 7.1

** Major Topics:**Economic Costs

Accounting Costs

Opportunity costs

Implicit and explicit costs

Sunk Costs

__Take good class notes on:
__The explicit algebraic relationship between the production function
and the cost function

** Read:** PR 7.2

Costs in the Short-run

TC, FC, VC, ATC, AFC, AVC, MC

Determinants of the shape of the SR cost curves

Typical U-shaped SR cost curves

** Read: **PR 7.3

TC,

Isocost Lines

Intercepts and slope TC = PK(QK) + PL(QL)

Shifting the isocost line

Changes in total costs

Changes in input prices

Isocosts and Isoquants: Choosing your input mix

Cost minimization with given input prices

The Expansion Path

** Read:** PR 7.4

Changing the size (scale) of the plant itself

Returns to scale and the LRATC curve

Determination of the shape of the LR cost curves

Constructing the LRATC curve

Shifting the LRATC

Technology

Input prices

** Read: **PR 7.6

The learning curve

*Now that we have derived the MPL and the APL from the total product
curve and explained the relationships between each, it is our next charge
to carry this over into the firms short-run and long-run cost relationships.
There exist direct and specific relationships between production theory
and cost theory; between the MPL, APL, and TPL curves mentioned above and
the MC, AC, and TC curves. Use the following as a guideline to explain
these relationships to yourself.*

** Be able to:** Define and explain the various definitions of costs in section
7.1

Explain the role of sunk costs in economic decision-making

Understand the conversion of a production information (which is purely technological information) to cost information (which incorporates information concerning input prices.)

What is the relationship between the TP curve and the TC curve?

What is the relationship between the APL curve and the AVC curve?

What is the relationship between the MPL curve and the MC curve?

Define and calculate SR costs: the ATC, AVC, AFC, & MC

Explain why SR cost curves are U-shaped

Explain an Isocost Line. What determines the slope of the isocost line? What determines the position of the isocost line? What happens when the P

What is meant by "the minimum cost input combination" ? How does this relate to the expansion path?

Explain the derivation of the LRATC curve

Explain why LR cost curves are u-shaped

Show how changes in technology and input prices affect cost curves

Explain the Learning Curve

__PROFIT MAXIMIZATION AND COMPETITIVE SUPPLY__

** Read: **Class Handout and PR 8.1

Profit Maximization

Ownership and control of the firm

Managerial consumption of leisure

Amenity maximization

Sales maximization

Internal controls

Governance structure

Proxy battles

Performance-based pay

External controls

Takeover

Competition

Financial capital markets

** Read: **PR 8.2

The assumptions of pure competition

Profit-maximizing firm behavior in competitive markets

** Read:** PR 8.3, 8.4, 8.5

Profits in competitive markets: The SR

Zero economic profits

Economic profits or losses

The competitive firm's supply curve in the SR

The shutdown point

The competitive industry's supply curve in the SR

Industry Supply = firm's supplies

SR elasticity of supply

Producer surplus (PS)

** Read:** PR 8.6

Profits in competitive markets: The LR

Long-run equilibrium

The crucial role of entry and exit

Market structure implications for cost and price minimization

Entry and economic rents

** Read:** PR 8.7

Increasing, constant, and decreasing cost industries

The Difference between SR and LR supply curves

** Read:** PR 8.8

** Be able to:** Write a short essay on the goals of a firm and how economists
justify the use of profit maximization as the primary goal

Explain the importance of price taking behavior in competitive markets

List the assumptions of pure competition

Explain the SR output decision for a competitive firm

Derive the firm's SR supply curve

Derive the industry's SR supply curve

Define and explain producer surplus

Explain the LR output decision for a competitive firm

Explain LR equilibrium, LR profits, and the role of entry and exit in the LR

Explain the effects of competitive markets on costs and prices

Derive a LR supply curve

Explain increasing cost, decreasing cost, and constant cost industries

Write a short essay on Contestable Markets

__Analyzing Competitive Markets__

** Read:** PR Chapter 9

Review of consumer surplus and producer surplus

Welfare conditions under pure competition

Pareto-optimality

Using supply and demand curves as marginal benefit and marginal cost curves

Price Controls - an upper limit on price

Natural Gas

Rent Controls

Price Minimums - a lower limit on price

The Airline Industry under the CAB

Agricultural markets

Limiting entry in tobacco and peanut markets

Price supports

Production quotas

Import quotas and tariffs

Taxation

Subsidies

* Read and Discuss *the Hayek article

The competitive model as a benchmark

** Be able to:** Show the distribution of CS and PS under competitive market conditions

Define pareto-optimality

Explain what effects we can expect if government sets price below the equilibrium price

Explain what effects we can expect if government sets price above the equilibrium price

Explain what effects price supports have on markets

Explain what effects production quotas have on markets

Explain the effects of a tax on a competitive market

Explain the effects of a subsidy on a competitive market

Be able to discuss the role of prices in a market economy (Hayek)

__MARKET STRUCTURES - PURE MONOPOLY__

** Read:** PR 10.1

The assumptions of pure monopoly

Profit-maximizing firm/industry behavior in monopolized markets

** Read: **PR 10.2

Mark-up pricing

The "disappearing" the supply curve

The effect of a tax on a monopolist

Operating in the elastic range of the demand curve

Measuring monopoly power

Monopoly and the "guarantee" of profit

The Lerner Index

Concentration Ratios (Class notes)

The Hirfindahl Index (Class notes)

** Read: **PR 10.3

** Read: **PR 10.4

Natural Monopoly

Regulating the natural monopolist

Marginal cost pricing versus Average cost pricing

** Read:** PR 10.7

** Be able to:**Explain the importance of price making behavior in monopoly markets

List the assumptions of pure monopoly

Discuss the profit-maximizing behavior of a monopolist

Discuss the pricing decision of the monopolist

Discuss the supply curve under monopoly

Discuss the relevant range of prices for a monopolist

Show how a tax could actually increase quantity offerings to the market

"Measure" monopoly power using the Lerner and Hirfindahl indices

Explain the major sources of monopoly

Explain the social or welfare costs of monopoly

Define a natural monopoly

Outline the pro's and con's of price regulation of a natural monopolist. Be sure to clearly delineate between MC pricing and AC pricing.

__The extraction of Consumer Surplus - Pricing decisions__

** Read: **PR 11.1 & 11.2

Three necessary conditions

Types of price discrimination

First degree or Perfect price discrimination

Second degree or Block pricing

Third degree or Segmented market pricing discrimination

** Read:** PR 11.3

Intertemporal Price Discrimination and Peak-Load Pricing

** Read: **PR 11.4

The Two-Part Tariff

** Read:** PR 11.6 -SKIP SPRING 2004

Advertising

** Be able to:** Explain why a firm would want to price discriminate

Outline the conditions necessary for price discrimination to be effective

Differentiate among 1st, 2nd, and 3rd degree price discrimination

Explain Intertemporal Price Discrimination

Explain Peak-Load Pricing

Explain how a firm must address the decision to advertise if it is going to profit maximize-SKIP SPRING 2004

** Monopolistic Competition**PR 12.1

Read:

SR equilibrium

Profits and Losses

LR equilibrium

"Excess Capacity" - the costs of differentiation

Comparison with pure competition

Advertising and the dynamic effects of product differentiation on cost curves (Class Notes)

** Be able to:** List the assumptions of monopolistic competition

Discuss the profit-maximizing behavior of a monopolistically competitive firm

Discuss the SR pricing and output decision of a monopolistically competitive firm

Discuss the LR pricing and output decision of a monopolistically competitive firm

Explain the role of entry and exit in the LR

Define and explain the concept of excess capacity in the LR

Compare the monopolistically competitive firm to the competitive firm

Discuss the static and dynamic role of advertising

** Oligopoly
Read: **PR 12. 2 - 12.6

Nash Equilibrium - define and explain

Cournot Equilibrium - define, explain, derive

Bertrand Equilibrium - define, explain, derive (homogeneous products only)

When to use Cournot and Bertrand Models

Competition vs. Collusion

The payoff matrix

The Prisoner's Dilemma

Implications of the Prisoner's Dilemnma for Oligopolisitic Pricing

Price Rigidity - Kinked demand curve model

Price leadership models by the low cost firm

Price leadership models by the dominant firm

Cartels and collusion

Formalized market coordination

Decisions required to form a cartel

Factors which make it easier to form a cartel

Why cartels fail

Informal market coordination

Discuss the profit-maximizing behavior of an oligopolist

Discuss the SR pricing and output decision of an oligopolist

Discuss the LR pricing and output decision of an oligopolist

Define, explain and derive a Cournot Equilibrium

Define, explain and derive a Bertrand Equilibrium

Conpare and contrast the uses of Cournot vs. Bertrand

Construct and use a payoff matric

Explain the Prisoner's Dilemma and use it in a payoff matrix analysis

Discuss the implications of the Prisoner's Dilemma for Oligopolistic Pricing - "Schizophrenia Pricing"

Develop the kinked demand curve model to explain price rigidity

Develop a price leadership model based on the low cost firm

Develop a price leadership model based on the dominant firm

Outline the decisions which are required to form a cartel

Outline the factors which make it easier to form a cartel

Explain why cartels eventually fall apart

** Game Theory and Competitive Strategy**PR 13.1 - 13.9

Read:

Dominant Strategies

The Nash Equilibrium Revisited

SKIP: Mixed Strategies

Repeated Games

Sequential Games

Threats, Commitments, and Credibility

Entry Deterence

Bargaining Strategy

Auctions

*Be able to:
* Explain the difference between cooperative and noncooperative games

Identify and explain dominant strategies in a payoff matrix

Show single and multiple Nash Equilibria in a payoff matrix

Explain the Nash Equilibrium in a beach location game

Explain how a repeated game affects choices (again using a payoff matrix)

Explain how a sequential game affects choices (again using a payoff matrix)

Explain why there is an advantage to moving first

Construct and use a payoff matric

Explain the Prisoner's Dilemma and use it in a payoff matrix analysis

Discuss the implications of the Prisoner's Dilemma for Oligopolistic Pricing - "Schizophrenia Pricing"

Develop the kinked demand curve model to explain price rigidity

Develop a price leadership model based on the low cost firm

Develop a price leadership model based on the dominant firm

Outline the decisions which are required to form a cartel

Outline the factors which make it easier to form a cartel

Explain why cartels eventually fall apart

*Disclaimer: The schedules and
procedures in this course are subject to change in the event of extenuating
circumstances.*

**Web page Last Updated on
January 26, 2005
**

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*© Bradley K. Hobbs, Ph.D. 2001. All written portions of
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Intellectual property rights are claimed over my intellectual product (Read
"Capitalism" by Ayn Rand.) *