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RL3

RL3. Review. Exam. Date: Room: Cumulative 2 hours (120 min) Closed book (calculators not needed) Format: Problems as in PS (no true false q) Course Grade: 25-20-20-35, Curve! Preparation Master all PS and past exams Read slides Read book. Consumer ’ s Theory.

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RL3

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  1. RL3 Review

  2. Exam Date: Room: Cumulative 2 hours (120 min) Closed book (calculators not needed) Format: Problems as in PS (no true false q) Course Grade: 25-20-20-35, Curve! Preparation Master all PS and past exams Read slides Read book

  3. Consumer’s Theory Fix (parameter) Budget set (plot, interpret slope) 4 types of preferences (plot, find interpret MRS, MT) Optimal choice (SoH, find analytically and geometrically) Magic formula for Cobb-Douglass! (derive it) Changes in p and m Substitution and Income effect Ordinary and Giffen, Inferior and Normal goods Real endowments (choice) Geometric representation Choice – buying and selling

  4. 3 applications Labor market - labor supply: w given Budget set, Choice, Labor Supply, Elasticity Intertemporal Choice: r given 2 periods: Budget set, Choice, PV, FV, CS Consumption smoothing 2) T periods: Annuity and perpetuity: PV formula Lease or buy, loan, pension plan, value of the bond Uncertainty: gamma given 1) Lottery, Bernoulli and VNM utility 2) Risk aversion and certainty equivalent 3) Insurance (fair insurance)

  5. Markets and Equilibrium • Many (2) agents • Edgeworth Box

  6. Markets: Competitive Equilibrium Competitive Equilibrium 1) Choices optimal given prices 2) Markets clear (supply=demand) Find CE analytically and geometrically. Tricks: 1) one price =1, 2) market clearing for only one good 3) magic formula! FWT: Competitive equilibrium is Pareto efficient!

  7. Competitive Equilibrium

  8. Competitive Equilibrium (Geometry)

  9. Are Markets Efficient?

  10. Pareto Efficiency

  11. Are Markets Efficient?

  12. Competitive Producers Producers have technology and maximize profit Properties of F( , ): RS, MPK, MPL Geometric representation: Isoquants SoH for Profit Maximization, Cost Minimization Profit maximization= cost minimization + choice of y Derive cost functions, shapes for IRS, CRS and DRS Supply function (also with fixed costs) Equilibrium with N producers Equilibrium with free entry (determine N)

  13. Market failure 1. Market Power One producer (Monopoly) = it has market power Demand Cost function Optimal choice, elasticity and markup (uniform price) TS, CS, PS, DWL Price discrimination (three types)

  14. Market failure 1. Market Power N firms Demand Cost function

  15. DWL

  16. Market failure 2. Externality Our utility/profit depends on action of others Positive and negative externality Problem strategic interdependence = Nash equilibrium Equilibrium : mutual best responses Special case of positive externality: Public good Pareto efficiency: Too little or too much? Free riding

  17. Market failure 3. Asymmetric Information Adverse selection (hidden information) Example: Buyers of cars know less then sellers 1) Separating equilibrium: good cars not traded 2) Pooling equilibrium: both cars traded Incentives for good types to send credible signals Credibility: for bad types too costly to pretend good ones Moral hazard (hidden action) Insurance contracts change incentives! Insurers should take it into account

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