RL3 Review

Exam Date: May 13th, 5:05 -7:05 p.m. Room: (A-K) SS 6210, (L-Z) Humanities 2650 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 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

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)

Markets and Equilibrium Many (2) agents Edgeworth Box

Markets: 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!

Competitive Equilibrium

Competitive Equilibrium (Geometry)

Are Markets Efficient?

Pareto Efficiency

Are Markets Efficient?

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)

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)

Market failure 1. Market Power N firms Demand Cost function

DWL

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

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