CH 1:
Value maximization principle: an allocation of goods and services is efficient if it maximizes
the total value for all involved agents
Welfare is maximized when P = MC
Neoclassical general equilibrium model: formalizes the idea that a system of prices can
achieve an efficient allocation. The model analyzes an economy with many producers and
consumers, assuming that each producer maximizes their own profit, and each consumer
maximizes their utility at the prevailing market prices. The main result of this is the
fundamental theory of welfare economics.
Fundamental theory of welfare economics: effect allocation goods emerges at competitive
eq.
Result remarkable because:
1. producers and consumers only need to know prices to achieve efficient allocation
2. behavior of products and consumers corresponds to interests of entire economy even
though all individuals only pursue own self-interest
Perfect competition market: P = AC = MC
Markets can be efficient in 3 main ways:
1. allocatively efficient (consumers value exceeds production value)
2. productively efficient (produced at lowest possible cost)
3. dynamically efficient (when finds efficient balance between production & consumption)
Market failure:
1. market power: selling p>mc
2. information asymmetry: party involved has more/better info
3. externalities
4. transaction costs: coordination costs, information asymmetry, imperfect commitment
Allocation of goods. And services is efficient is there is no redistribution of goods & services
possible in which one person would be better off, without anyone else being well off
W=CS+PS
Welfare is at maximum if P=MC
Fundamental theorem of welfare economics: efficient allocation of goods is achieved in a
competitive equilibrium. the government plays a limited role in this
,CH 4:
Prisoner’s dilemma is a simultaneous-move game
Nash equilibrium: player strategies form a nash equilibrium if none of the players has a
reason to choose a different strategy, given the strategy of other players.
Hoteling game:
• Can choose from more than two actions
• Product differentiation
• Best response is to locate just to the right or just to the left.
• Only nash eq. is that clint and dennis are both in the middle.
Limitation hoteling game: based on fixed prices.
CH 7:
Subgame perfect nash equilibrium:
• As a solution for dynamic games
• Decisions not made at the same time
• Backward induction
Double marginalization problem:
• (monopolist) Every company in chain adds a profit margin to original marginal costs.
If company controls entire chain, only one profit margin is added. This leads to a
lower price and higher welfare.
, Vertical chain: series of companies, exploit raw materials to companies that sell end
products to consumer
CH 2:
Linear contracts: w+BQ
Non-linear contracts: when agent receives a bonus when they reach a certain target or
obtains specific number of share options in company.
Critical assumptions principal agent model
1. Agent not budget constraint
2. accepting contract unattractive for risk-averse agent
3. output perfectly measurable (depend on imperfect performance measure)
4. agent only performs a task
5. agent output objectively measurable
Equal compensation principle: agent will only make an effort for both tasks if marginal rate
of return is the same for both
Is agent’s output is not objectively measurable, but the principal assesses it subjectively, it
can rely on an subjective effort evaluation – a “relational contract”
CH 5:
Individual incentive contracts can have two practical setbacks:
1. optimal contract dictates that each team member becomes his/her own claimant of
his/her contribution to output which can be costly to firm
2. individual output partly determined by non-observable factors outside control of a
member of the team.
Solution: comparative performance evaluation (=employee payment based on their
performance relative to the performance of other employees)
Disadvantages comparative performance method:
1. provides team members with small incentive to help others
2. team members can sabotage other team members which improves their own
performance
3. members of team may collaborate and decide not to work hard (does not affect
performance)
Value maximization principle: an allocation of goods and services is efficient if it maximizes
the total value for all involved agents
Welfare is maximized when P = MC
Neoclassical general equilibrium model: formalizes the idea that a system of prices can
achieve an efficient allocation. The model analyzes an economy with many producers and
consumers, assuming that each producer maximizes their own profit, and each consumer
maximizes their utility at the prevailing market prices. The main result of this is the
fundamental theory of welfare economics.
Fundamental theory of welfare economics: effect allocation goods emerges at competitive
eq.
Result remarkable because:
1. producers and consumers only need to know prices to achieve efficient allocation
2. behavior of products and consumers corresponds to interests of entire economy even
though all individuals only pursue own self-interest
Perfect competition market: P = AC = MC
Markets can be efficient in 3 main ways:
1. allocatively efficient (consumers value exceeds production value)
2. productively efficient (produced at lowest possible cost)
3. dynamically efficient (when finds efficient balance between production & consumption)
Market failure:
1. market power: selling p>mc
2. information asymmetry: party involved has more/better info
3. externalities
4. transaction costs: coordination costs, information asymmetry, imperfect commitment
Allocation of goods. And services is efficient is there is no redistribution of goods & services
possible in which one person would be better off, without anyone else being well off
W=CS+PS
Welfare is at maximum if P=MC
Fundamental theorem of welfare economics: efficient allocation of goods is achieved in a
competitive equilibrium. the government plays a limited role in this
,CH 4:
Prisoner’s dilemma is a simultaneous-move game
Nash equilibrium: player strategies form a nash equilibrium if none of the players has a
reason to choose a different strategy, given the strategy of other players.
Hoteling game:
• Can choose from more than two actions
• Product differentiation
• Best response is to locate just to the right or just to the left.
• Only nash eq. is that clint and dennis are both in the middle.
Limitation hoteling game: based on fixed prices.
CH 7:
Subgame perfect nash equilibrium:
• As a solution for dynamic games
• Decisions not made at the same time
• Backward induction
Double marginalization problem:
• (monopolist) Every company in chain adds a profit margin to original marginal costs.
If company controls entire chain, only one profit margin is added. This leads to a
lower price and higher welfare.
, Vertical chain: series of companies, exploit raw materials to companies that sell end
products to consumer
CH 2:
Linear contracts: w+BQ
Non-linear contracts: when agent receives a bonus when they reach a certain target or
obtains specific number of share options in company.
Critical assumptions principal agent model
1. Agent not budget constraint
2. accepting contract unattractive for risk-averse agent
3. output perfectly measurable (depend on imperfect performance measure)
4. agent only performs a task
5. agent output objectively measurable
Equal compensation principle: agent will only make an effort for both tasks if marginal rate
of return is the same for both
Is agent’s output is not objectively measurable, but the principal assesses it subjectively, it
can rely on an subjective effort evaluation – a “relational contract”
CH 5:
Individual incentive contracts can have two practical setbacks:
1. optimal contract dictates that each team member becomes his/her own claimant of
his/her contribution to output which can be costly to firm
2. individual output partly determined by non-observable factors outside control of a
member of the team.
Solution: comparative performance evaluation (=employee payment based on their
performance relative to the performance of other employees)
Disadvantages comparative performance method:
1. provides team members with small incentive to help others
2. team members can sabotage other team members which improves their own
performance
3. members of team may collaborate and decide not to work hard (does not affect
performance)
