ECO 211

Microeconomics (Slavin)

Chapter 2

Scarcity --> Requires choices on how to best use your resources.

Opportunity cost, your next best alternative.

The Productions Possibilities Frontier (PPF) -- an illustration of scarcity.  A graph representing all possible combinations of two goods that an economy can produce given its limited resources. 

- Points inside the line are attainable, but economy has unemployed resources (it can do better.)
- Points on the curve are the best the economy can do (full employment).
- Points outside of the line are unattainable given current resources.

When the PPF is linear (straight), there are no specialized resources.  When the PPF is curved, that means resources are specialized, and the Law of Increasing Costs applies (the more you shift your resources toward producing one good, the greater the opportunity cost in terms of the other good becomes).

Chapter 4

Purpose of an Economy is to answer the questions of resource allocation: what to produce; how to produce it; for whom to produce it (who consumes it)?

1. Capitalism -- private ownership of resources; market forces determine resource allocation.

2. Socialism -- public (aka government) ownership of resources; central planning replaces market.

3. The Mixed Economy -- a mix between capitalism and socialism. The US falls in this category.

4. Communism -- not same as socialism; idealized state of organized anarchy.

Role of Government in a Mixed Economy

1. Referee in disputes.

2. Regulation of private sector.

3. Redistribution of income (transfer payments, ie, welfare, etc.).

4. Levy taxes -- to pay for services; also used as means of regulating behavior.

5. Handling of "Market Failures" (externalities and public goods).

The Market System

1. Profit drives all voluntary exchange. Adam Smith: the "Invisible Hand". All voluntary exchange benefits both parties involved, otherwise exchange would not take place at all.  [Book: Wealth of Nations]

2. Price Mechanism serves 2 purposes: (a) rationing device -- makes sure people who value resource the most are the ones who get it; (b) communication between producer and consumer -- how the consumer tells the producer how much to make.

3. Competition yeilds 2 benefits: (a) lower prices for consumers; (b) innovation -- making the product better than the other guys', and finding more efficient ways to produce in order to lower prices.

A Brief History of Civilization (not in book)

Suggested reading:  Toffler, Alvin & Heidi. Creating a New Civilization. (1995)

Agrarian economy -- ancient times - c.1800 AD.   Agriculture the basis of the economy.  Majority of people involved in growing food.  No mass production.

Industrial Revolution -- c.1800 - 1950's.  New technology leads to mass production, specialization.  Rise of large corporations.   Less and less % of population involved in growing food, but technology makes farms more productive.  (Currently, <2% of US population grows more than enough food for entire country.)

Information Age -- 1950's - present.  (1956 first year that workers in service-based jobs outnumbered blue-collar workers.)  (1) Shift away from industrial to service-based production, similar to decline in agricultural sector above.  Trading in information/data/knowledge, instead of physical goods.   (2) Increased specialization of jobs -- harder to move between jobs.  (3) Movement toward smaller, more flexible firms.  (4) Increased interaction between consumer and producer -- more "personalized" products.  Advances in telecommunictaions, internet, interactive TV, Home Shopping.

Chapter 5

The First Law of Demand: ceterus paribus (all else constant), if price goes up, quantity demanded goes down, i.e., if bread gets more expensive, you buy less bread. A change in price effects ONLY quantity demanded (cet. par.).

Determinants of Demand: income (make more $$, buy more stuff)... price of substitute goods (price of Coke goes up relative to Pepsi, you buy less Coke (quantity demanded) and your demand for Pepsi goes up)... price of complimentary goods (price of cereal goes up, demand for milk goes down)... number of consumers in market (more people buy more stuff)... taste/consumer preference.

Law of Supply: ceterus paribus, if price goes up, quantity supplied goes up; if the price you can get for Spam goes up, you want to start selling more Spam.

Determinants of Supply: input prices / cost of production (able to produce less at any given price)... price of substitute goods (if McD's can get a better price for chicken sandwiches than for Big Macs, they will shift their resources toward the production of chicken sandwiches)... price of complimentary goods (if the market price of shoes goes up, you make more shoes (Law of Supply), ergo, you need to start making more shoelaces)... number of suppliers in the market (more companies can make more stuff).

Chapter 6

Own-price Elasticity of Demand (ed) -- Measure of how responsive quantity demanded (Qd) is to a change in price (P).  Elasticity =  % change Qd / % change P

Formula:   ed = (P1 / Q1) * [(Q1-Q2) / (P1-P2)]

   Always negative (First Law of Demand).   Usually stated in terms of absolute value:  |ed|

   |ed| > 1 -- relatively elastic demand.  % change in Qd large relative to % change in P.

|ed| < 1 -- relatively inelastic demand.  % change in Qd small relative to % change in P.

|ed| = 1 -- unit elastic.  % change in Qd = % change in P.

Determinants of ed: 

1. availability of substitutes -- demand more elastic where substitutes are more readily available.

2. necessity vs. luxury -- demand for necessity tends to be more inelastic.

3. portion of budget -- tend to be more elastic for "big-ticket" purchases.

4. time -- the longer someone has to adjust to a price change, the more elastic demand becomes. 

ed and the Demand curve -- We call a flatter demand curve relatively more elastic.  A steeper demand curve is more inelastic.   [Memory device:   stretch a rubberband -- notice it is flat when you stretch it -- this is elastic.]

    On any downward-sloped Demand curve:   The upper portion of the curve will be relatively elastic, the lower portion will be relatively inelastic.  The midpoint of the curve is unit elastic.

Total Revenue (TR) and ed -- Total Revenue = P * Q

            Marginal Revenue (MR) = change in Total Revenue with the sale of one more unit of the good.

    When demand is relatively elastic, a price increase decreases Total Revenue.  (MR > 0)

    When demand is relatively inelastic, a price increase will increase Total Revenue.  (MR < 0)

    Total Revenue is maximized at unit elastic point (where MR = 0).

First Exam

Chapter 7 - Utility & Consumer Surplus (CS)

Utility = pleasure or satisfaction from consuming good or service.   --  Purely subjective.  Can only measure    indirectly by how much consumer is willing to pay for a good.

Marginal Utiltiy (MU) -- how much pleasure is gained from consuming one more unit of the good.

    Law of Diminishing MU -- each successive unit consumed yields less and less MU.

Total Utility -- S MU  The total pleasure derived from all units consumed.

    Consumers are utility maximizers.  They will consume until MU = 0 (where Total Utility is maximized).  This is the point of indifference.  Beyond this point (where MU < 0) Total Utility will diminish.  

PROBLEM:  Goods & services are not free.  Therefore, MU must be balanced with Price (i.e., what you are willing to pay vs. what you have to pay).  

    Consumers will consume until (MU / P) = 1  (i.e., MU = P). 

    Equimarginal Rule -- the MU / P will be equal for the last unit of every good consumed.  (In this case, 1 = 1 = 1...) 

ANOTHER PROBLEM:  Not only are goods not free, but your budget is limited.  You may not be able to consume to the point where (MU / P) = 1.  In this case, you will still consume all goods so that the MU / P will be equal for the last unit of every good consumed (Equimarginal Rule).

Relative vs. General Price Changes:

    Relative -- where the price of only one (or a few) goods change, but the rest do not.  Will result in  (1) income effect -- price increase (for example) effectively lowers the value of your income; therefore, you can afford to buy less of everything.  (2) substitution effect -- will buy less of more expensive good and more of cheaper good.  [Two effects may offset one another.] 

    General -- the price of all goods changes (a.k.a., inflation).  This produces only an income effect.

Consumer Surplus (CS) -- When MU > P, the additional utility you didn't have to pay for is CS.   Example:  You buy a lobster at a seafood restaurant.  You really like lobster, and would be willing to pay $10 for one, but the price the restaurant charges you is only $8.  You got $2 worth of CS. 

    CS is graphically represented by shading the triangular region above the price and below the Demand curve on the S&D graph. 

Chapter 8 -- Supply

[Good illustration of Law of Supply on p.143 of Slavin textbook]

Elasticity of Supply -- es -- measure of responsiveness of Qs to Price.  Always positive (Law of Supply). 

    FORMULA:  es = (P1 / Q1) * [(Q1-Q2) / (P1-P2)]   (same as formula for ed, except using Qs instead of Qd).

Application of es & ed:  When a tax is imposed on a producer, how much, if any, of the cost of that tax is passed on to consumer?  The greater the |ed|, the more of the tax burden is borne by the supplier.  The greater the es, the more the tax burden is borne by the consumer. 

Chapter 9 -- Cost & Profit

Costs: 

1. Fixed costs -- costs of production that do not change no matter the level of output (even if output =0).

2. Variable costs -- change with level of output.   Increase with higher output, decrease with less output.

3. Total costs (TC) -- Fixed + Variable

4. Marginal cost -- how much Total cost changes with one more unit of output.

Short Run vs. Long Run -- In the Short Run there are fixed costs.  In the Long Run, all costs are variable (i.e., you can sell off assests, get new plant & equipment, etc. in order to alter your fixed costs). 

    In Short Run:  As long as your Total Revenue (TR) is at least equal to your Variable Costs, you will continue to operate.   If TR < Variable Costs, you shut down (temporarily cease operation). 

    In Long Run:  If your TR < TC, you sell off your assests and go out of business. 

Average Costs:

1. Average Fixed Cost = fixed costs / output

2. Average Variable Cost (AVC) = variable costs / output

3. Average Total Cost (ATC) = total cost / output, or AVC + AFC.  This is the per-unit cost of production.  (This is different from MC -- we will add ATC & AVC to our chart:)

Firms are profit maximizers or loss minimizers. -- Profit = TR - TC, or (Price - ATC) * Output

**RULE:  Profit is maximized / loss is minimized when MR = MC.**

    When (& only when) price is fixed (flat Demand curve), MR is the same as Price.

*Example:  In the above table, if the firm charges a fixed price of $200, it will produce an output of 4 units.*

Chapter 10 -- Long & Short-run Supply

• In Short run, firm will shut down if Price < AVC 

            Point where MC curve passes through AVC curve is the Shut Down Point.

            Short run Supply curve is the MC curve above the Shut Down Point.

• In Long run, firm will go out of business if Price < ATC

            Point where MC curve passes through ATC curve is the Break Even Point.

            Long run Supply curve is the MC curve above the Break Even Point.

Remember that you always are operating in the Short Run -- i.e., the present is always the short run.  You use the Long Run for planning. 

Remember that in the Long Run, all costs are variable -- there are no fixed costs.  Therefore, when planning for the long run, you can observe costs at various levels of output.  For example, you can compare your ATC and MC curves for producing with one plant, vs. the ATC and MC for producing with two plants, vs. three plants, etc.

    If you draw all of these cost curves and connect the break even point of each with a line, that will be the Long Run Average Total Cost (LRATC) or "Planning" Curve.  Typically, the LRATC curve is "U"-shaped.

• Economies of Scale -- the downward-sloped portion of the LRATC curve.   As firm increases its level of production by adding new plant and equipment, ATC decreases (i.e., the bigger your operation, the cheaper per unit it is to produce).   This is a concept borrowed from engineering.

• Diseconomies of Scale -- the upward-sloped portion of the LRATC curve.   Once a firm gets "too" big, it starts to become less efficient, therefore, its per-unit cost of production (ATC) begins to creep upward.

                A firm will be inclined to operate at the minimum point on the LRATC curve, taking full advantage of Economies of Scale, without becoming so large as to expect diseconomies of scale. 

• Constant Returns to Scale (CRS) -- a concept we don't deal with much in this class, but this would be a flat LRATC curve.  Average cost of production remains the same no matter the level of output. 

Chapter "X" -- Economics of Information (Not in the book)

    Earlier in the class, we discussed the Information Age.   Now, we can define the meaning of that a little more clearly.  When we refer to information, we are refering to (i) information sought by producers about their customers, in order to better determine the types of products that they most want to consume, (ii) information sought by consumers in order to allow them to make better purchasing decisions, and (iii) just general information, such as the ability to look up facts about killer whales on Yahoo.com. 

    The purpose and result of advances in information technology is to make information less costly to acquire.  Information is a good (maybe even a resource), and, since there is a cost associated with getting it, information is scarce.  When information becomes less expensive to acquire, firms are not only able to provide their customers with better service and a more customized product, but they are able to operate more efficiently, bringing down their costs of operation. 

    As I said, information is not free.  Even if there is not a monetary cost involved in acquiring it, there is likely an opportunity cost.   What's more, the more information you attempt to acquire (i.e., the more and more specific), the greater the cost becomes.  As you approach 100% (perfect) information, the cost begins to grow exponentially, so that perfect information could only be acquired at infinite cost.  Therefore, perfect information on any subject is not possible (even though in some of the models we are going to discuss in subsequent chapters, perfect info will be one of the assumptions).  (There is also the matter of how you know if you have perfect information -- there's always going to be someone who comes along who knows something you don't.)

    Given that there is a cost associated with information, how much information will you gather before you stop?  You will gather information until the Marginal Utility (benefit) of the info is equal to the Marginal Cost of acquiring it.  Before this point, there is still some benefit to be gained from gathering more info; after this point, gathering more information will be counterproductive, as the cost of acquiring it will exceed any benefit it may yield.

Means of Communicating Information -- an application:  Quality Assurance.

1. Brand Names -- Consumer will be willing to pay more for a brand-name good because he is compensated by the reduced cost of information about the product.  A firm will work to associate a certain level of quality with its brand name, so that consumers will recognize it.  When we see a brand name on something, we automatically have a good idea of the quality and other attributes of the product.   We know what we are getting.

2. Guarantees / Warranties -- a firm "puts it money where its mouth is".  This is a promise by the firm that the product will do what they claim it will do.  If it does not live up to the expectations that they put forth, they obligate themselves to reimburse the customer his cost of purchase or the cost of repair.  This removes some of the risk (risk is the the probability that an unanticipated cost will be imposed) from the consumer.  This greatly increases a product's saleability.  Again, consumers will pay more for a good that has a guarantee or a warranty than they will pay for a good that does not.

3. Sunken Cost -- similar to a warranty, except that instead of offering to pay the consumer if something goes wrong, the company puts its money on the line up front.  Examples are celebrity endorsements -- you know those celebrity spokesmen get paid a fortune for their endorsement; the only way the firm can make that money back is to sell a lot of product; if they make a bad product they won't get repeat business so they lose money.  Another example (same idea, different situation):   when banks require you to make a down-payment on a loan.  If you were to default having made no downpayment, what have you really lost financially?  But the more your downpayment up front is, the less likely you will be to default on the loan, because the more money you've already given the bank, the more you have to lose. 

Some consequences of imperfect information:

1. Adverse Selection -- when the selling price of a good does not reflect its true value.  The classic example of this is used cars.  Suppose you have a car you want to sell.  It is in excellent condition, it's reliable, and you know for a fact that it is worth every penny of $5000.  However, because of imperfect info, the buyer does not know this.  He has no idea whether the car is a lemon or if you are really telling the truth (how does he know you're not a liar?).  Therefore, you will not be able to sell the car for its full value, in order to compensate the buyer for the risk he is taking due to his lack of information.  The downpayment on a loan mentioned above is also an example of adverse selection.  (Note:  banks require higher downpayments from customers that they deem to be riskier.)  You may take out a loan fully able and bound by your personal code of honor to pay it back, but the bank does not know that due to imperfect info.  Therefore, they will charge you a higher downpayment than they would in reality need to in order to satisfy themselves that they have reduced the risk of your defaulting.

2. Statistical Discrimination -- when people are lumped together in groups and are treated as more or less identical due to imperfect discrimination.   Example:  Car insurance -- all else equal, women are charged lower rates than men because, statistically, they are safer drivers (?!).  Higher rates are also charged to drivers under the age of 25 for the same reason.

3. Moral Hazard -- the risk that someone will behave differently than anticipated at the time of transaction.  Example:  shirking -- neglecting duties.  For example, say you are involved in a group project for this class, and one member of the group winds up doing all of the work, while the others shoot spitballs at the trashcan.  Due to imperfect info, as far as I am able to know, all the members of the group pulled their weight equally, so even though you were one of the goof-offs, you get the same grade as the one who did all of the work. 

Exam 2

Chapter 11 -- Perfect Competition

Assumptions (in this unit, the assumptions are very important -- the model grows out of the assumptions):

1. Very large number of suppliers -- individual firms are price takers, i.e., no one firm is large enough to have any influence on the market price by increasing or decreasing output.  They face a fixed price, represented by a flat (perfectly elastic) demand curve.
2. Products are standardized, that is, one firm's product is identical in every way to every other firm's product.  There is no differentiation [differentiation - where products are perceived by consumer as different].  As a result, every firm's product is a perfect substitiute for all of the others.  This adds to the perfectly elastic demand -- if one guy tries to raise his price, he will lose 100% of his business, because consumers will simply substitute another good for his.
3. Easy entry and exit -- we are assuming firms can start producing in this industry or go out of business at virtually no cost.
4. Perfect information -- consumers know everything about everyones product, so they cannot be deceived into believing that differentiation is there when it is not.

When dealing with models of competitive industries, you have to use two graphs:   The market S&D, and the individual firm's S&D. 

• Market Demand curve (the sum of all the individual firms' demand curves) is downward-sloped.  The market price is determined by the equilibrium -- where market D intersects market S.
• The Firm Demand curve -- the individual firm faces a flat demand curve, because its price is fixed at the market price; they cannot charge a price higher than market price.  The firm's output will be the point where its demand (MR) curve crosses its supply (MC) curve.  Since this is the profit maximizing / loss minimizing level of output, the firm will not charge a price below market price either.  (Homogeneity is kind of an unspoken assumption -- i.e., we assume all firms in the industry have the same cost curves.)

    If firms in a perfectly competitive industry are making a profit (i.e., P > ATC), then in the long run, enough new competitors will enter the market (easy entry & exit assumption) to shift the market Supply curve outward, lowering the market price until P = ATC for all firms in the industry.  Therefore, in the long run, firms in a perfectly competitive industry operate at zero profit.

    If market price falls below the firms' ATC, so that firms are making a loss, in the long run, enough producers will go out of business until the market Supply curve decreases, raising the market price back to the zero profit level.

One reason why perfectly competitive industries don't exist in "real life":

        If the industry is a decreasing cost industry, that is, an industry that experiences economies of scale (see Ch.10), then that firm has an incentive to use whatever profits it may manage to accumulate to get bigger, so that it can bring down its ATC and undercut its competitors.  Once this happens, the firm has become large enough to have some influence on market price, so that a perfectly competitive industry no longer exists.  This has happened in agriculture, where large corporate farms have undercut smaller family-owned farms because of economies of scale. 

    For the record:  The opposite of a decreasing cost industry is an increasing cost industry, where firms experience diseconomies of scale.   Which type of industry it is just depends on the product and the way it's produced.

Chapter 12 -- Monopoly

Assumptions:

1. Only one producer in the market -- no competitors.  Firm is a price maker; it determines what the market price will be, since it is the entire industry.  A monopolist faces a downward-sloped Demand curve. *(MR doesn't = Price anymore)* 

2. Only one product, so no differentiation.  No close substitutes, so no competition.  (For simplicity, we'll assume the firm only makes one good.)

3. Restricted entry -- either because of prohibitive cost (see "natural monopoly" below) or by legal restriction.

Creation of a Monopoly:

1. Gov't action (example: patents -- designed to allow inventor to own monopoly on the his invention by preventing anyone else from duplicating it.)

2. One firm owns an important resource and keeps other firms from using it.   (example: DeBeers owns the only diamond mines in the world.  They don't let anyone else sell their diamonds.  Therefore, they have a monopoly in the diamond wholesale market.)

3. Economies of scale -- explained in #1 of the following section...

Types of Monopoly:

1. Natural Monopoly -- a monopoly created by economies of scale.   Suppose the electrical industry is a decreasing cost industry (which it is).   Pretend that in the beginning you had several competing electrical companies.   However, like we discussed in the previous chapter, there is an incentive for each of these firms to get bigger, either by expanding their operation or by buying out their competitors.  Suppose Duke Power was able to grow faster than any of the others.   By the time Duke reached the minimum point on its LRATC curve, it was the only power company left.  It is now a natural monopoly.  Any power company attempting to enter the market will not be able to compete with Duke's prices because they will be too small, so Duke's monopoly is protected by prohibitive entry costs. 

2. Local Monopoly -- there is only one seller of a good within a given geographical location.  Example, depending on where you live, Duke Power is the only company you can buy power from.  Northland Cable TV is the only cable provider to which you can subscribe.  If you're sitting in the Carmike 7 movie theater and you get hungry, the only place to buy food is at the concession stand (which is why movie theater concession stands are so expensive).

3. Regulated Monopoly -- firm's behavior is control by the gov't.   Example: Duke Power (the perfect example of any type of monopoly) cannot raise its rates unless allowed by the gov't.  All of their production is also closely regulated.

The Monopolist's Demand Curve is the Market Demand curve.  It is downward-sloped.  MR not = Price.  Check it out:

        Q             P             TR                 MR    

        1           1700         1700             1700

        2           1650         3300             1600

        3           1600         4800             1500

    Notice that MR is decreasing faster than Price (which is the Demand curve).  The slope of the MR curve will actually be twice as steep as the slope of the D-curve.  (Again, sorry I can't draw it -- see book.) 

    The Monopolist is a price maker.  They can pick the price they charge.  The output at which they will produce will be... everyone say it together... where MR = MC.  The price they will charge will be the point on the Demand curve directly above where the MR & MC curves intersect.  (see picture in book).  The price charged by monopolies will tend to be higher than that of a competitive firm.  Monopolists do not always necessarily make a profit; remember MR=MC is also the loss-minimizing level of output.  If the monopolist does not make a profit over a long enough period of time, they will go out of business.

Welfare Costs of Monopoly (why monopolies are generally bad):

1. Deadweight Loss -- A monopolist increases his profits by restricting output.  In effect, the monopolist is "capturing" some of the consumers' surplus (from Ch.7) and converting it into profit for himself (we call this "quasi-rent").  This in itself is undesirable to consumers, but it is not "bad".  The bad part is because output is restricted, there is consumer surplus and also producer surplus that just goes away.  It is benefit to society lost because those goods were never produced.  This is deadweight loss.   (Def.: producer surplus is the difference in what a producer would be willing to sell his product for and the price his is actually able to get -- the inverse of CS. Illustrated as the area above the Supply curve and below the price.)

2. Lost benefits of competition -- Because a monopoly does not face competition, they have less incentive to be efficient.  Whereas a competitive firm will tend to want to keep their costs of operation down so as to undercut their competitors, a monopolist doesn't care if his costs creep up.  This leads to higher prices to consumers, and wasteful uses of resources.  Monopolies may also incur additional costs by using resources to lobby the gov't for laws to protect their monopoly ("rent-seeking").  Monopolies also tend to be less innovative than competitive firms. 

A monopolist does not have free reign, though.  If deadweight losses get too big, or prices creep up too much due to inefficiency, one of two things may happen:

1. Gov't intervention and regulation.
2. Potential competition -- even though there are no close competitors, there is still the potential for competition should the monopolist's prices get too extravagant.  Say Duke Power's electrical rates go through the roof.  It will eventually become less expensive for people to start buying solar panels and installing them on their homes.

Chapter 13 -- Monopolistic Competition

Assumptions:

1. Large number of firms (but less than in perfect competition).

2. Differentiated products -- this is the defining factor of monopolistic competition.  Imperfect substitution.  Firms in effect have a "mini-monopoly" in their product (eg., McDonald's is the only place you can get a Big Mac, even though you can get a hamburger in plenty of other places).  Firms engage in non-price competition -- If they can convince their consumers that their product is better than their competitors', then the consumers may be willing to pay more for it. 

3. Easy entry and exit.

4. Imperfect information (which reinforces differentiation -- recall that differentiation is the consumer perception that one firm's product is different from anothers).

As with perfect competition in Ch.11, we have to use two graphs:   market S&D, and the firm S&D.

    The market demand curve is downward-sloped.   The market price is at equilibrium (where Supply curve intersects Demand curve).   However, since there are not as large a number of firms as in perfect competition, individual firms are not price takers, so the market price here does not determine the firm price, but rather it is an average of all the individual firms' prices (some will be higher some lower -- we do not assume homogeneity, as we did with perfect competition).  

    The firm also faces a downward-sloped demand curve; however, because there is some substitution between different firms, the firm demand curve will be flatter (more elastic) than the market demand curve.  This is because a price increase in McDonald's hamburgers will cause some consumers to substitute away to Burger King's or Wendy's hamburgers, but, since BK and Wendy's are still in the same industry, it doesn't effect the market Quantity demanded.

        Because the firm is a "mini-monopoly", it is able to set its output at the level where MR=MC.  It will be able to set its price like a monopoly does (although, because of the flatter demand curve, the price won't be as high as in the case of a monopoly).  Consumers desire differentiation and are willing to pay more for it, and since the market S&D are in equilibrium, there is no deadweight loss in a monopolistically competitive industry.  Also, since the industry is competitive, there are none of the other welfare losses associated with monopolies.

--To this point, the monopolistically competitive model is an excellent reflection of what we see the most in "real-life", such as the competition between fast-food joints, supermarkets, drugstore chains, department stores, etc.  Here we see firms, some of which are making substantial profits.  However, when we add the easy entry and exit assumption, it looks a little bit less like "reality". --

    If we assume easy entry and exit, in the long run, monopolistically competitive firms will operate at zero profit.  This is because, so long as there is any profit being made by any of the firms, new competitors will enter, increasing the market supply curve, thus decreasing the market price. 

        Also, each firm's demand curve will decrease, because the extra competition will draw some of the consumers away.   Think about the firms in the industry as dividing up customers like college students dividing up a pizza.  If you get more people around the table, everyone gets less pizza.  In the same way, more competitors lowers the demand faced by each firm in the industry.  Eventually, each firm's demand curve will lower to the point where their price will equal their ATC, and they will operate at zero profit.

Chapter 14 -- Oligopoly

It's hard to say, even harder to model...  Assumptions:

1. Very small number of firms (literally, 2 or 3).

2. There can be standardized or differentiated products.

3. Difficult (costly) entry and exit (less restrictive than in monopoly).

The key feature of oligopoly is the interdependence between firms.   One firm's actions greatly effects those of the other firms.  This leads to strategic behavior of the firms in the industry -- that is, they will act so as to influence the actions of its competitors, or out of reaction to their competitors' actions.  In order to model this, we have to use game theory.

    Two types of games:

1. Dominant strategy game -- where there is one best move regardless of what the other guy does.

2. Sequential game -- move/countermove.  No dominant strategy.   One player waits to see what the other one does; like a chess game.

The kinked demand curve (from Appendix to Ch.14):

    Assume a duopoly (an oligopoly with only 2 firms) -- Ford and General Motors.  Pretend we're GM. 

        If we raise our prices, Ford will likely not follow our price increase, but will rather decide to take advantage of the opportunity to undercut us and take some of our business.   Therefore, this will be a relative price increase -- this yields both an income and substitution effect (see Ch.7).  That means our demand curve will be relatively elastic (flatter) when we raise our prices.

        If we lower our prices, Ford will probably follow our price decrease, so we won't undercut them.   This means that the price of both Ford and GM cars will go down, which is a general price decrease -- this yeilds only an income effect, so we will gain less business from lowering our prices than what we would lose from raising them.   The demand curve when we lower our prices is relatively  more inelastic (steeper) than when we raised our prices above. 

    If we combine these two curves, we wind up with a "kinked" demand curve that is flatter above our current price and steeper below.

Collusion and Cartels

    Collusion is when firms within an industry that are supposed to be competing with one another conspire to increase their control over the market.  We will discuss other types of collusion in the next chapter.  For now, we'll concentrate on Cartels and Keiretsu.

        A cartel requires:

1. An oligopolic industry.

2. Standardized products.

3. Barriers to entry (legal, cost, or threat of violence)

    Examples of cartels are OPEC, the Colombian drug cartels, Standard Oil (from next chapter). 

    A cartel is where firms in the industry conspire to restrict output in order to increase the price.  In effect, a cartel behaves exactly like a monopoly, with all the members working together as if one firm.  Cartels come with all of the welfare costs that a monopoly does. 

        A cartel comes with its own self-destruct button, though, because each member constantly has the incentive to cheat on the arrangement.  If Kuwait (a member of OPEC) is assigned to produce 100,000 barrels of oil per day, and they are getting a really high price for it, their natural inclination is to increase production to take advantage of the inflated price (Law of Supply).   Once they do this, the market price drops, and the entire cartel arrangement falls apart. 

Keiretsu is a Japanese form of industry (it is legal in Japan).   There are two types of keiretsu:

1. A number of firms that produce completely different types of goods that are centered around a bank.  Examples of this type are Fuji (film, electronics, other stuff) and Mitsubishi (cars, electronics, Japanese "zero" planes used in WWII, etc.).  Fuji and Mitsubishi are actually the names of Japanese banks.

2. One major firm and its suppliers.  An example is Toyota, which produces cars, and all of the firms that produce its seat covers, engine parts, body panels, etc.

Chapter 16 -- Mergers and Antitrust

Concentration -- the degree to which an industry is controled by a few firms (i.e., the market share held by the top few firms in the industry).  Most commonly measured by the Herfindahl-Hirschman Index (usually just called the Herfindahl Index).  This number is found by squaring the % market share of each firm in the industry and adding them together. 

In the late 1800's, several "trusts" (cartels) arose and exercised monopoly control over several important industries, including the Standard Oil Trust, the Vanderbilt Railroad Trust and others.

Sherman Antitrust Act (1890) -- prohibited contracts and collusion that restricted competition; prohibited conspiring to monopolize any part of the market.

        Rule of Reason -- must prove harm done by anticompetitive acts.  This is the standard currently being used in the Microsoft case.

        Per Se Standard -- no need to prove harm done.  Examples of per se violations are price fixing and predatory pricing.

Clayton Act (1914) -- clarification of Sherman.  Specifically outlined prohibited practices.

1. Price discrimination (not strictly enforced except in case of predatory pricing).
2. Interlocking shareholding (where it interferes in competition).
3. Interlocking directorates (in firms within same industry).
4. Tying contracts (done on case-by-case basis).
5. Exclusive Dealings.

Federal Trade Commission (FTC) -- established in 1914 to enforce Sherman and Clayton.  Now primarily concerned with fraudulent advertising cases.

Celler-Kefauver Anti-Merger Act (1950) -- prohibits mergers that reduce competition.  Federal courts review proposed mergers and determine its effect on concentration in the industry.  Enforcement seems rather haphazard.

3 types of Mergers:

1. Horizontal -- between two firms that are on the same level of production in same industry (ex., merger between two banks, drug stores, pharmaceutical companies, long distance companies, etc.)
2. Vertical -- between two firms on different levels of production (ex., merger between a power company and a coal mine, a gasoline wholesaler and a service station, an automobile manufacturer and an engine-parts manufacturer, etc.)
3. Conglomerate -- involving firms in completely different industries.   Example:  ITT (telecommunications) merged with Sheraton (a hotel chain).   Done for the purpose of diversification -- hedging against losses within one industry by spreading assets into other industries.  (Don't confuse with "differentiation".)

Exam 3

Chapter 18 -- Labor Unions

During the early Industrial Revolution (1800's), the Labor Market, which we will study in the next 2 chapters, was still in its infancy.  Small family farms were failing due to falling food prices, and workers had no choice but to go to work for industry.  In many cases, a factory was the only major employer in a town (Monopsomy), so that anyone there who needed to work had to work for that factory; as a result, there was no competition between employers for workers.  The combination of these two factors led to poor working conditions and low pay in many cases. 

One such company was the Pullman Railroad Car Co.  Pullman actually owned the houses where the workers lived and the general store where they bought food and clothing.  Pullman was charging the workers high rent and high prices for supplies so that many workers actually went into debt to the company.  In 1894, the workers went on strike.  The strike was ruled illegal by the government under Sherman (last chapter), and it was broken up and its leaders jailed.

1914 -- Clayton Act (also from last chapter) exempted labor unions from Sherman.  However, the courts enforced this rather narrowly, so union activity was still not well tolerated by the gov't.

1926 -- Railway Labor Act -- required railroad companies to negotiate with labor representatives.

1932 -- Norris-LaGuardia Act -- restricted Federal intervention in labor disputes -- Feds no longer broke up strikes, except where a vital national interest was concerned (i.e., threatened national security), or where things got violent.

1935 -- Wagner Act (aka, National Labor Relations Act) -- prohibited unfair labor practices by employers (i.e., interference in union elections, threatening or bribing workers not to join union, etc.)  Established the National Labor Relations Board (NLRB) to oversee labor-management relations. Intended to allow labor and management to come to the table as equals.

1938 -- Fair Labor Standards Act -- (i) outlawed child labor (cannot work over a certain number of hours if under 16 years of age) (ii) established the minimum wage (iii) established the 40-hour workweek and overtime pay.

1947 -- Taft-Hartley Ammendment to the Wagner Act -- prohibited unfair labor practices by unions.  Prohibited the closed shop.  -- Four types of "shops" established by the labor contract:

1. Closed shop -- can only hire workers who are already members of the union.   (Illegal under Taft)
2. Union shop -- once workers become employees, must join the union.
3. Agency shop -- workers aren't required to join union, but must still pay dues (go figure)
4. Open shop -- workers are not required to join union or pay dues, but will still be represented at labor negotiations by the union.

    Taft also allowed individual states to pass Right to Work Laws.   In a right to work state, union shops and agency shops are illegal, so that unions may only operate open shops.  South Carolina is a right to work state.  (At one point there were some in Congress who wished to pass a national right to work law.)

1959 -- Landrum-Griffin Act -- (i) established a "bill of rights" for union members (ii) set procedures for union elections (iii) laid out financial responsibilities of union leaders.

Collective Bargaining -- the term used for the negotiation process between labor (represented collectively by the union) and management.  This negotiation produces the Labor Contract, which lays out:

1. wages -- contract may be in effect for as long as 3 years, so it has to have a means of compensating for inflation built in.  Management and labor will negotiate the size of annual cost of living adjustments (COLA) based on what they expect inflation to be over the duration of the contract. 
2. benefits -- health and dental insurance, retirement, vacation days, sick leave, etc.
3. grievance procedures -- who do you gripe to if the floor manager is riding you too hard.   Must follow a specific chain of command.
4. job security / seniority -- the first one hired is the last one laid off.  This is ensured by the contract.
5. job descriptions -- each worker is presented with a job description, as determined by the contract, when he is hired.  It is what is expected of him -- this is to keep managers from adding work to their employees; also aids in job security, since management won't be able to consolodate jobs in order to downsize labor force.

    If the unions can't get what they want, they go on strike.  If management is unhappy, they lockout the workers.  The net effect of both of these weapons is the same.

Problems & controversy with unions in modern times:

1. Corruption -- example is the election of Ron Carey (no relation) as president of the Teamsters Union.  Despite close gov't supervision, the election was discovered to be riddled with corruption.  The gov't forced another election, and Jimmy Hoffa, Jr. was elected.  Some union leaders are often alledged to have ties to organized crime (mafia). 
2. Inefficiency of contracts -- since labor contracts may set wages for up to 3 years, firms are not able to adjust their costs of operation in order to stay competitive.   This can cause problems when American firms must compete with non-unionized foreign manufacturers.  Adherence to specific job descriptions can also cause inefficiency, since one union worker is not allowed to do the job of another union worker, they may not be able to deal with routine problems (like a burned out lightbulb) in a timely manner.   It is also sometimes very difficult to fire a union worker, even if they are not doing their job. 
3. Political contributions -- in the 1996 general election, union leaders contributed large amounts of money to the Democratic Party.  However, 40% of the rank-and-file members of the unions (workers) voted Republican.  In effect they were unwittingly contributing their union dues to candidates that they did not support.  Congress proposed a "Paycheck Protection" law, which would require union leaders to gain permission from individual members before using their dues for political contributions.   So far as I know, this has never been passed.

    All of these controversies and others have led to falling union membership over the past few decades.  It is unclear whether unions will recover from this trend, or if their time has passed.  Ultimately, the answer will be determined either by politicians or by the labor market.  -- This is Rob Carey, TCTC News, signing off.

Chapter 17 -- Demand in the Factor Market

Derived Demand -- demand for inputs (Land, Labor, Capital) is derived from the demand of the final good they are used to produce.  Example:   An increase in the demand for new homes will result in an increase in the demand for lumber, which, cet. par., will result in higher lumber prices.

* Demand for resources is subject to the First Law of Demand (if the Price of an input goes up, the Quantity demanded of that input goes down).   Therefore, the demand curve is downward-sloped.*

Determinants of Factor Demand:

1. (As we just said) Demand for the final good.

2. Productivity of the resource.  output / units of input.   Example:  If you can string 100 tennis rackets a day with 20 workers, or do the same amount with one machine, all else equal, your demand for capital will increase and your demand for labor will decrease.  The demand shifts toward the more productive resource.

3. Prices of Substitute Resources -- Suppose you run an automobile factory.  You can either use workers to assemble your cars or robots.  If the UAW Union demands higher wages, cet. par., you will tend to decrease your quantity demanded of labor, and increase your demand for capital.  (Analogous to the Coke/Pepsi example in Ch. 4).  Demand shifts toward the cheaper resource.

4. Prices of Complementary Factors -- If you are a textile mill and the price of a particular type of loom goes down, you will tend to increase your quantity demanded of capital.  If you buy more looms, you need workers to run them, so you will increase your demand for labor.  (#'s 3 & 4 may sometimes offset each other to some degree.)

Marginal Product (MP -- book uses "MPP") -- how much output increases when you add one more worker. 

*(I'll use labor as the example, but keep in mind the same applies to land and capital as well.)* 

This is different from productivity of a resource (#2 above).   It is the same mathematical relationship as ATC and MC, with productivity being the average productivity of your workers.

    Each additional worker will tend to increase output less than the previous worker did -- this is the Law of Diminishing Marginal Returns.

Marginal Revenue Product (MRP) -- MP * Marginal Revenue.  If MP is how many more units each worker produces, and MR is how much income the firm gets from selling each additional unit of output, then MRP is how much additional income the firm gets from the output of one additional worker.  It is essentially a $ value of what that worker is worth to the firm. 

    If we graph MRP, it will be downward sloped because of the Law of Diminishing Marginal Returns.  Since MRP is how much the firm values each additional worker, i.e., how much the firm would be willing to pay for each additional worker, MRP is the demand curve for the resource.

Marginal Factor Cost (MFC) -- the cost of each additional worker to the firm.

The firm will hire until MRP = MFC, i.e., the firm will continue hiring so long as the value of the worker to the firm (MRP) is > or = how much the worker costs the firm (MFC).  The following table provides an example:

This firm will stop hiring after 5 workers, because the value of the 6th worker to the firm (MRP) is less than what they have to pay him (MFC).

Chapter 19 -- The Labor Market

We looked at the Demand for Labor (and other resources) in the previous chapter.  In this chapter, we will focus on Labor Supply (SL) and equilibrium in the Labor Market.

    Keep in mind that in the Labor Mkt, Supply comes from households and Demand comes from the firms. 

When we talk about SL, we are talking about workers having to decide between leisure time and work.  We define leisure as any time not spent on the job (it includes things we might not consider "leisure", such as mowing the lawn and painting the house).  The opportunity cost of work is foregone leisure, and the opportunity cost of leisure is foregone wages from work. 

    Therefore, the SL curve is upward-sloped, because employers must pay workers higher wages to get more hours of work, in order to compensate the worker for his foregone leisure time.  Each additional hour of work will cost the employer successively more (SL = the MFC of labor). 

At extremely high income levels, we can experience a backward-bending SL curve.  This is because at high levels of income, the worker can afford the opportunity cost of foregone wages in order to enjoy more leisure time.  (This is why we often see corporate CEO's on the golf course or taking tennis lessons more often than we see factory workers spending time at the country club.)

The Determinants of SL:

1. Taste -- when a certain job becomes popular or fashionable, we see an increase in the supply.  Example:  Engineering is an extremely popular major at Clemson Univ.  This results in a high supply curve of engineers. 

2. Number of suppliers in the market (i.e., size of the workforce).

3. Price of substitute use of resource (i.e., how much you could get paid for working somewhere else).  Example:  Suppose the Milliken plant in Spartanburg paid its workers $12/hour.  Now suppose they build the BMW plant in Greer and they pay their workers $15/hour.  You might expect Milliken to see a decrease in its supply of workers as people leave to work for BMW.

Skilled and Unskilled Labor

    Skilled labor is work that is either highly technical or professional -- requires specialized training or education. 

    Unskilled labor is non-technical or highly repetitive work -- requires no extensive specialized training.

    Skilled and unskilled workers are noncompeting groups.  For example you would not expect to see a doctor applying for a job as a burger-flipper at McDonald's.  Likewise, you wouldn't expect someone whose only work experience was flipping burgers to go to work as a brain surgeon.  This is why you see completely different wage scales for different types of jobs -- they have totally different S&D curves.  How much a lawyer gets paid for working a case has no direct impact on what a person working for McDonald's makes, because these two workers are not competing for the same jobs.

        Since skilled labor is highly specialized, there also exist noncompeting groups among skilled workers.  For example, a surgeon will not be competing for a position at a law firm without first going through extensive reeducation.  It would be fairly easy for an unskilled worker to change jobs, however, since there is no such need for extensive retraining. 

Discussion of Minimum Wage

Minimum wage is a price floor (a minimum price someone is allowed to charge for, in this case, their labor).  If the minimum wage is set above the going market wage rate (set by the equilibrium of SL&DL), it will result in an increase in the quantity supplied of labor and a decrease in the quantity demanded of labor.  In other words, there will be a labor surplus (more workers than jobs, a.k.a., unemployment).  However, if the minimum wage is below the market wage rate, it will have no effect.  [Current minimum wage is $5.15/hr., proposed to increase to $6.15/hr. -- the current market wage rate (average of all workers) is $13.37 -- this is as of 11/99.]

    This is where noncompeting groups comes in:  an increase in minimum wage may cause unemployment in the few sectors of the labor market that still pay minimum wage (usually small "mom & pop" -type businesses), but it will likely have no effect on most jobs, which pay well above minimum wage.   Any conclusions as to the merits are left to the student.

Chapter 22 -- International Trade

Law of Comparative Advantage (long version):

Robinson Crusoe is stranded alone on a desert island.  There are only two sources of food: fish and coconuts.  RC has a specific Production Possibilities Frontier for fish & coconuts (5 fish & 0 coconuts, 0 fish & 5 coconuts, or any combination in between).  Now, one day, as the story goes, RC is walking along the beach when he spies a set of footprints that are not his own.  Turns out there's this other guy named Friday who has been living on the other side of the island. 

RC and Friday decide to join forces.  When they compare their Production Possibilities (Friday can produce 5 fish & 0 coconuts, 0 fish & 10 coconuts, or any combination in between), they discover that Friday has a lower Marginal Opportunity Cost (MOC) for producing coconuts, that is, in order to produce one more coconut, he must forego catching less fish than RC would have to give up in order to produce an additional coconut.  In other words, Friday is the lower-cost producer of coconuts.  Likewise, they discover that RC is the lower-cost producer of fish.   They decide to specialize and engage in trade.  RC will catch all the fish, since he can do so at a lower MOC than Friday, and Friday will pick all of the coconuts.  It works out that RC is able to catch 5 fish per day, while Friday is able to pick 10 coconuts.

In order to engage in trade, they have to agree on an exchange rate -- they decide that they will trade 3 coconuts for 2 fish.  So, RC trades 4 fish for 6 coconuts.  Remember that before trade, RC could only pick 5 coconuts a day, but then he would not have time to catch any fish.  Now, he's eating 6 coconuts, and 1 fish!  RC is now able to consume beyond his ability to produce on his own.   Likewise, Friday is now consuming 4 fish and 4 coconuts per day.  Friday is also consuming beyond his own production possibilities.  These are the gains from trade:  Both parties benefit -- both are able to consume at a level beyond their own ability to produce on their own.

The Law of Comparative Advantage (short version) -- all parties will benefit when each specializes in the production of those goods in which they have the lower marginal opportunity cost.  [Originally stated by David Ricardo.]

Special Problems of applying to International Trade:

1. Must take into account fluctuating international exchange rates.   For example if the Yen-to-Dollar ratio falls (i.e., it takes less yen to buy a $ or more $'s to buy a yen), Japanese goods will become more expensive in the US.  This will tend to complicate our fish & coconut example.

2. It is difficult to move resources (land, labor and capital) between countries.  If the US were to specialize in the production of fish and Japan in the production of coconuts, you would want to shift any resources used in the production of each to the country where they are going to be needed.  That may not be so easy, though (it would be very costly to relocate an entire factory from the US to Japan for example).

3. It's not fish & coconuts.  What we actually look at are labor-intensive goods vs. land-intensive goods vs. capital-intensive goods.  By "labor-intensive", we mean that labor is the most important resource involved in producing that good.  Land is the most important resource in producing a land-intensive good (agriculture is a good example of a land-intensive good).

Theoretically, a country that has the most productive land resources would specialize in the production of land-intensive goods.  The country with the most productive labor force would specialize in labor-intensive goods, etc.

Restrictions on International Trade:

1. A tariff is a tax on an import.  The purpose of a tariff is to increase the cost of importing goods from other countries, which of course decreases that good's suppy curve, which raises its price to consumers.  By artificially jacking-up the price of foreign goods, the gov't protects domestic producers from competition.

2. A quota is a limit on the quantity of a good that can be imported.  This decreases the good's supply curve simply by reducing the number imported.  This has the same effect as a tariff in that it drives up the price of the foreign good.

3. An export subsidy is not really a trade "restriction", but its purpose is similar, so I'll include it here.  A subsidy is where the gov't gives money to a firm to enable it to produce at a lower cost.  This increases the supply curve of the domestic firm allowing it to charge a lower price than its foreign competition.

    "Free Trade" is what we call international trade without any of these restrictions.

    Trade Restrictions

• Help owners of domestic firms that may be forced out of business by foreign competition and the workers at these firms who might otherwise face layoffs.

• Hurt consumers who will pay higher prices and may get lower-quality goods (due to reduced competition) and some workers who work in industries dependent on imports. 

    Arguments for imposing trade restrictions:

1. National security -- (i) some goods cannot be exported by law in order to prevent their being used against the US.  (Example: encryption software, nuclear weapons technology, certain computer systems technology, stuff...)  Also, (ii) certain domestic industries (such as oil production) are necessary for the country to continue operating in the event of our being cut off from the outside world either by a blockade or by war.  To make sure we don't lose our ability to produce these goods, certain trade restrictions may be imposed to keep them from going out of business.

2. Politics -- "trade sanctions" are often used to punish or persuade other countries whose behavior or politics we don't agree with.  Example: South Africa in the 1980's in opposition to Aparthied.  Saddam Hussain in Iraq to punish him for the Gulf War.

3. Retaliation for trade restrictions placed on us by other countries.   This happens every few years with Japan.  When this sort of thing happens over an extended period of time, we call it a "Trade War".

4. Protectionism -- the political philosophy that American industries and jobs must be protected against any losses due to foreign competition. 

A (very) brief overview of Public Choice Economics (extra -- not in book)

Public Choice is a cross-over between Political Science and Economics.   It is involved, among other things, with the study of bureaucracy, or public (gov't) agencies.  These are gov't -run organizations that produce or provide:

1. Public goods (goods not produced in the private sector -- see Ch.4).

2. Private goods (that could be produced in the private sector) that are produced by the gov't for various reasons.

3. Regulation of the private sector (see Ch.4).

There are two competing theories as to the motivation of gov't agencies' behavior:

1. Capture Theory -- the idea that the managers of the public agencies (a.k.a., "bureaucrats") act entirely out of self-interest.  That their behavior is fashioned so as to benefit themselves.  Since one of the assumptions we stated at the beginning of this class was the "self-interested individual", we tend to subscribe to this theory.  More in a minute.

2. Public Interest Theory -- the idea that managers of public agencies act for the sole purpose of benefiting society. 

Assumptions (in addition to self-interest) -- we assume that the bureaucracies we are modeling (1) must compete with other gov't agencies for funding and (2) face no competition from the private sector (i.e., hold a monopoly).

Model #1 -- the bureaucrat

Anthony Downs groups bureaucrats into two groups:

1. Climbers seek to maximize their own income, power and prestige.   They tend to do this through organizational expansion.  Constantly expanding their agency benefits them by:

   1. bringing in "new blood" with fresh ideas.  This tends to impress the guys in Congress holding the purse when it comes time to compete for funds with other agencies.

   2. it is easier to gain promotion within the organization by creating new positions than to wait around for someone to retire or get fired.

   3. it is easier to increase ones power by increasing the number of subordinates than to try to increase ones power over the people already under him.

2. Conservers seek to maximize their own security and convenience.   Conservers tend to be resistant to change, even positive change, because it might just be too risky.  Where conservers dominate the agency, you might tend to see lots of out-dated methods of doing things.

It is my own theory that both groups may coexist within the same agencies.   The agency's behavior will be influenced by which of the two is more dominant.   Either way, with climbers always adding new stuff and conservers refusing to get rid of the old, you wind up with a lot of inefficiency.

The process by which agencies are budgeted tends to penalize efficiency.   Say your agency's budget for FY1999 is $100 million.  You bring in some go-getter from the private sector who is used to keeping costs down, and your agency winds up only spending $80 million in 1999.  When you go to the legislature for your next year's budget, they will look at what you spent in '99 and decide you don't need as much as you were budgeted last year, and they will slash your budget.  Whether you're a conserver or climber, you don't like that.

Model #2 -- the agency:

Oliver Williamson's "Cost-Push" Model states that agencies tend to increase their costs of operation from one year to the next in order to prevent cuts in their funding.  This is the same idea as the creeping costs we discussed with monopolies in Ch.12, except that gov't agencies do this on purpose, according to Williamson.

Model #3 -- the agency:

William Niskanen postulates (I threw that $5 word in for free) that bureaucracies tend to overproduce in order to increase their budgets from one year to the next. 

Niskanen also refers to the informational advantage that agency managers have over their appropriators.  He refers to bureaucrats as the "gatekeepers of information".  For example, if you are a Congressman, and you need to know how much $ the military needs in order to operate next year, who is the most qualified to fill you in?  Answer: the Pentagon.  Therefore, the agency is able to influence its appropriators to make sure its budget keeps expanding.

My conclusion (strictly my idea):

If climbers are dominant within an agency, the agency will tend to behave along the lines of the Niskanen Model.  If conservers are dominant in the agency, it will behave more like the Williamson Model. 

Summary of the Clemson University data I refered to in class:

* Keep in mind that there is not enough data here to establish any trends with any degree of certainty -- I'm strictly using this as an illustration. *

Notice the large increases in enrollment in the last two years of the data.  This is consistent with the Niskanen Model (increasing output -- for a college, students are output). 

Also note the expenditures per student on instruction (spending directly related to output) over the entire time period -- except for the period 87-88, they are decreasing, while, at least for the first two years, total expenditures (including spending not directly related to output) increases.  This would be consistent with the Williamson Model. 

The End