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Microeconomics exam 3 Cheat Sheet (DRAFT) by

Covering price discrimination, monopolistic competition and advertising, oligopoly and strategic behavior, consumer decision-making, and behavioral economics and risk-taking

This is a draft cheat sheet. It is a work in progress and is not finished yet.

Price Discri­min­ation

price discri­min­ation
the practice of selling the same good or service at different prices to different groups of customers
perfect price discri­min­ation
the practice of selling the same good or service at a unique price to every customer (set at their max willin­gness to pay)
First Degree Price Discri­min­ation
perfect price discri­min­ation where the firm will charge a person based on their exact willin­gness to pay
Second Degree Price Discri­min­ation
Firms will offer discounts based on bulk purchasing
Third Degree Price Discri­min­ation
Firms will charge different prices based on differ­ences in price elasticity of demand (ex. movie theatre conces­sions or student discounts)
Conditions for Price Discri­min­ation
distin­gui­shing groups of buyers with different price elasti­cities of demand, preventing resale,

Monopo­listic Compet­ition and Advert­ising

Monopo­listic Compet­ition
a type of market structure charac­terized by low barriers to entry, many different firms, and product differ­ent­iation
Product Differ­ent­iation
the process firms use to make a product more attractive to potential customers
the difference between the price the firm charges and the marginal cost of production
Excess Capacity
phenomenon occurring when a firm produces at an output level smaller than the output level needed to minimize average total costs
in monopo­lis­tically compet­itive indust­ries...
- economic profits are zero and are the same as perfectly compet­itive markets
- MR < Price
- price is more likely to be higher than perfectly compet­itive industries because of the cost of variety
- it is ineffi­cient because price does not equal minimum ATC
- long run equili­brium, Price = ATC, Price > MC
Monopo­listic compet­ition charac­ter­istics
low barriers to entry, many different firms, and product differ­ent­iation
production differ­ent­iation in...
style or type, location, and quality

Oligopoly and Strategic Behavior

a form of market structure that exists when a small number of firms sell a differ­ent­iated product in a market with high barriers to entry
an agreement among rival firms that specifies the price each firm charges and the quantity it produces
a group of two or more firms that act in unison
Antitrust Laws
laws that attempt to prevent collusion (that is, prevent oligop­olies from behaving like monopo­lies)
Mutual Indepe­ndence
a market situation where the actions of one firm have an impact on the price and output of its compet­itors
Price Leadership
phenomenon occurring when a dominant firm in an industry sets the price that maximizes its profits and the smaller firms in the industry follow by setting their prices to match the price leader
Price Effect
how a change in price affects the firm's revenue
Output Effect
how a change in price affects the number of customers in a market
Game Theory
a branch of mathem­atics that economists use to analyze the strategic behavior of decisi­on-­makers
Prisoner's Dilemma
a situation in which decisi­on-­makers face incentives that make it difficult to achieve mutually beneficial outcomes, when the socially optimal strategy doesn't equal the dominant strategy
Dominant Strategy
in game theory, a strategy that a player will always prefer, regardless of what his opponent chooses
Nash Equili­brium
a phenomenon occurring when all economic decisi­on-­makers opt to keep the status quo (neither player has na incentive to switch their strategy given what the other player is doing)
a long-run strategy that promotes cooper­ation among partic­ipants by mimicking the opponent's most recent decision with repayment in kind
Backward Induction
in game theory, the process of deducing backward from the end of a scenario to infer a sequence of optimal actions
Decision Tree
diagram that illust­rates all of the possible outcomes in a sequential game
Sherman Antitrust Act
the first federal law (1890) limiting cartels and monopolies
Clayton Act
law of 1914 targeting corporate behaviors that reduce compet­ition
Predatory Pricing
the practice of a firm delibe­rately setting its prices below average variable costs with the intent of driving rivals out of the market
Network Extern­ality
condition occurring when the number of customers who purchase or use a product influences the quantity demanded
Switching Costs
the costs incurred when a consumer changes from one supplier to another
Prisoner's dilemma dominant strategy
rat out your partner to avoid jail time

Consumer Decision Making

a measure of the level of satisf­action that a consumer enjoys from the consum­ption of goods and services
a personal unit of satisf­action used to measure the enjoyment from consum­ption of a good or service
Marginal Utility
the additional satisf­action derived from consuming one more unit of a good or service
Dimini­shing Marginal Utility
condition occurring when marginal utility declines as consum­ption increases
Consumer Optimum
the combin­ation of goods and services that maximizes the consumer's utility for a given income or budget (MU/P is equal across products)
Substi­tution Effect
(1) the decision by laborers to work more hours at higher wages, substi­tuting labor for leisure; (2) a consumer's substi­tution of a product that has become relatively less expensive as the result of a price change
Real-i­ncome effect
a change in purchasing power as a result of a change in the price of a good
Diamon­d-water paradox
concept explaining why water, which is essential to life, is inexpe­nsive, while diamonds, which do not sustain life, are expensive
Indiff­erence Curve
a graph repres­enting the various combin­ations of two goods that yield the same level of personal satisf­action, or utility
Maximi­zation point
the point at which a certain combin­ation of two goods yields the greatest possible utility
Budget constraint
the set of consum­ption bundles that represent the maximum amount the consumer can afford
Marginal rate of substi­tution (MRS)
the rate at which a consumer is willing to trade one good for another along an indiff­erence curve
Perfect substi­tutes
two goods the consumer is completely indiff­erent between, resulting in a straig­ht-line indiff­erence curve with a constant marginal rate of substi­tution
Perfect comple­ments
two goods the consumer is interested in consuming in fixed propor­tions, resulting in a right-­angle indiff­erence curve
if combin­ation of something one loves and something one hates
maximum utility is gained from purchasing maximum quantity of the thing one loves

Behavioral Economics and Risk Taking

Behavioral Economics
the field of economics that draws on insights from experi­mental psychology to explore how people make economic decisions
Bounded Ration­ality
the concept that although decisi­on-­makers want a good outcome, either they are not capable of performing the problem solving that tradit­ional economic theory assumes or they are not inclined to do so; also called limited reasoning
Gambler's Fallacy
the belief that recent outcomes are unlikely to be repeated and that outcomes that have not occurred recently are due to happen soon
Hot Hand Fallacy
the belief that random sequences exhibit a positive correl­ation
Framing Effect
a phenomenon seen when people change their answer depending on how the question is asked (or change their decision depending on how altern­atives are presented)
Priming Effect
phenomenon seen when the order of the questions influences the answers
Status Quo Bias
condition existing when decisi­on-­makers want to keep things the way they are
Intert­emporal Decisi­on-­Making
planning to do something over a period of time, which requires valuing the present and the future consis­tently
Ultimatum Game
an economic experiment in which two players decide how to divide a sum of money
Risk-A­verse People
those who prefer a sure thing over a gamble with a higher expected value
Risk-N­eutral People
those who choose the highest expected value regardless of the risk
those who prefer gambles with lower expected values, and potent­ially higher winnings, over a sure thing
Preference Reversal
phenomenon arising when risk tolerance is not consistent
Prospect Theory
a theory suggesting that indivi­duals weigh the utilities and risks of gains and losses differ­ently