Why does a decrease in interest rate reduces the velocity of money circulation? I have seen sources that claim high interest rates increase the velocity of money circulation, but haven't really seen any concrete explanation for this. This is how I think it works: High interest rates -> high opportunity cost of holding money -> Demand for money decreases -> people dont want to hold money and will spend it -> higher velocity of income.

On the other hand,wouldn't a high interest rate make saving more attractive and thus reducing the velocity of income circulation?

EDIT: Sources that apparently claim this are referred to below:

This source does not explicitly state the relationship but somewhat explains the causes: http://thismatter.com/money/banking/money-demand-money-velocity.htm

A wikipedia page that seems reasonably credible states this relationship, but I am unable to fully understand their explanation:
https://en.wikipedia.org/wiki/Velocity_of_money

This exam question from Cambridge International Examinations that explicitly states the relationship (the correct answer is D)

You are absolutely right. Since higher interest rates increase the opportunity cost, you wan't to get rid of it faster (at the margin).

The core of the argument is that the cost stems not only from the amount of money holdings, but also from the duration. Say you are constrained about the amount of money holdings you need in your daily life, but you can still make sure the money is not idle for too long.

For the second part of your question, you are mixing up concepts. The interest rate influences the Consumption/Savings Decision, but it is the same decision problem as in a (model) world without money, i.e. it is a choice between real variables, whereas money velocity is a monetary question.

Low velocity results in low interest rates - not the other way around.  And with a higher demand for money, there is a lower need to economize on your holdings.
And the principal reason why velocity has fallen is the impoundment and idling of savings in our payment's system. Banks are "Black Holes".  Banks do not loan out existing deposits.  Banks pay for their earning assets with new money.  All bank-held savings (funds held beyond the income period in which received), are lost to both consumption and investment, indeed to any type of payment of expenditure.
“Why are the time deposits not invested? Simply because the commercial banks are carrying on their balance sheet a liability that is owned by the nonbank public (not the commercial banks), that cannot be used unless the nonbank public decides to use it, and by definition it is not being used. You cannot write a draft against it, the banks cannot use it, the public is not using it, so it is not being used.”
It is no happenstance that velocity has fallen when non-M1 components relative to total checkable deposits rose from a proportion of 3.23 to 1 in Dec. 1993 to 13.76 to 1 by Feb. 2008 thereby destroying money velocity.
People fall down the rabbit hole. Income velocity may be a "fudge factor," but the transactions velocity of circulation is a tangible figure. Vi is a “residual calculation - not a real physical observable and measureable statistic.”
I.e. Dr. Milton Friedman's income velocity, Vi, is endogenously derived and therefore contrived (N-gDp divided by M) whereas Vt, is an “independent” exogenous force acting on prices.
As Dr. Philip George posits: “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”
See: G.6 Debits and Deposit Turnover at Commercial Banks
http://bit.ly/2pjr81u
The decline in income velocity, MZM velocity, since 1981 parallels the decline in the transactions’ velocity. The decline in velocity was directly caused by the impoundment of monetary savings in the payment's system, i.e., caused by the FDIC raising deposit insurance levels from 40,000 dollars to 250,000 dollars and the complete deregulation of interest rates for specifically the member banks.
Link: http://www.philipji.com/item/2014-04-02/the-velocity-of-money-is-a-function-of-interest-rates


What is the effect on GDP when foreigners buy lots of domestic bonds? I am trying to figure out the effect on GDP of foreigners buying lots of domestic bonds. From what I understand, when foreigners buy lots of domestic bonds:

They need to convert their foreign currency into the domestic currency. This increases the demand for the domestic currency, leading to appreciation of the domestic currency. This appreciation of the currency makes domestically produced goods more expensive to foreigners, while making foreign goods cheaper. Exports fall and imports rise. Net exports fall. Therefore, GDP decreases.

The influx of foreign money into bonds causes bond prices to rise, and bond yields to drop. The increased demand for bonds leads to lower bond yields. As a result, domestic firms will find it easier to borrow money. This leads to an increase in investment. Therefore, GDP rises.

Is my understanding correct? What am I missing? In the real world, when foreigners buy lots of bonds, what happens to the GDP?

For every buyer there is a seller. If a foreigner buys a bond, that means a domestic investor sells it to them (or issuer). Why should the identity of who owns the bond matter?

In practice, there are many moving parts. One feature of financial crises is that investors buy U.S. Treasury bonds as a flight to safety. This means that purchases coincide with the weakening economy created by the financial crisis.


Is Bill Gates wrong about supply demand curves? In a recent tweet (Aug 14th, 2018, reproduced below), Bill Gates said that supply demand curves don't work for software because the first unit costs a lot and every unit after that is free. Isn't this just modeled by a horizontal supply line?

At the time I was in college, this was basically how the global economy worked...

This chart assumes that the total cost of production increases as supply increases. When a car company makes a new vehicle, the 10th car costs the same to manufacture as the 1000th.
But software doesn’t work like this. Microsoft might spend a lot of money to develop the first unit of a new program, but every unit after that is virtually free to produce.
Unlike the goods that powered our economy in the past, software is an intangible asset -- “something you can’t touch.” And it’s not the only example: data, insurance, e-books, even movies work in similar ways.
The portion of the global economy that doesn’t fit the old model just keeps getting larger. But the rules that govern the economy haven’t kept up. This is one of the biggest trends in the global economy that isn’t getting enough attention.
If you want to understand why this matters, I highly recommend the new book “Capitalism Without Capital” by @haskelecon and @stianwestlake. Here’s my review: link.

No, Bill Gates is correct here. The simple econ 101 cross model is based on a separation of the supply and demand side. Firms are price takers, they assume they can sell as much as they want at the prevailing price and their output decisions have no impact on the price. If firms are not price takers, they have to explicitly take into account how the demand side reacts since this determines the impact on prices. Now with huge returns to scale, price taking is usually not a sensible assumption and therefore the econ 101 cross an inappropriate model.

Yes, Gates is wrong

If there was just one customer for a piece of software, the software would be cheaper than for two customers.  With just one customer, it can work in just one way.  For the second customer, it has to be more flexible.

You can see some quick examples of this in Microsoft Windows 10.  It has seven different versions for different customers.  Beyond that, it has a multitude of configuration options.  Yet a single customer will tend to use just one configuration and stick with that.

Gates is correct to say that software is different.  It does have greater returns to scale than cars.  But cars also reduce price with scaling and face the problem of needing to be configured for multiple uses.  Software isn't unique.  Books always had a similar problem (writing the book is a huge part of the initial cost while actually printing the book is much cheaper).  E-books accentuate that, but it's still the same problem.

Insurance

Gates is laughably wrong about insurance.  Insurance is not all first customer cost.  Insurance improves with scale more like cars do.  The first customer is exceptionally risky, as the company either has to pay out or not.  If not, the insurance premium is all margin.  If the company does pay out, then it almost certainly loses money on that customer.  Additional customers amortize that risk.  The more customers, the lower the risk, even though the payout increases.

Insurance companies work because customers can pool their risk together.  Customers pay a small amount of money so that if an unlikely event happens, they can avoid paying out a large amount of money.  The larger the pool, the lower the risk.  But even a gigantic pool still adds payout, on average, with each customer.  The payout becomes more predictable, not less in amount.

If there is a one in a hundred chance of something happening that costs \$1000 and an insurance company has one customer,  then the premium needs to be really high.  There's an argument that it needs to be \$1000, as otherwise the company won't have enough money to pay off the claim if it occurs.  But if the company has a hundred thousand customers that cost \$5 to obtain and maintain, the company could charge \$15 per customer.  It would expect to pay \$1 million on that many customers, or \$10 per customer.  Add the \$5 and there you go.  The company collects \$1.5 million and pays out \$1 million.  The remaining \$.5 million goes to staffing and other overhead.

That's a simplified model, but it's how supply works in insurance.  The first customer is the most expensive because the first customer is also the riskiest.  After a while, the marginal cost settles to an approximately constant value.

Cars work the same way.  Initially there are design and prototyping costs.  The initial car may be made by hand rather than assembly line.  So the first car, the concept car, is really expensive.  Subsequent cars are cheaper and eventually they move production to the assembly line.  Ideally the car would occupy an entire assembly line for a year.  But some cars don't sell that well, so they also have to retool the line at least once to make a different car.

Retooling is expensive, so they try to avoid it by things like working twenty-four hours on another line instead.  Or they build ahead so that they don't have to produce more of the current car after retooling.

Again, my point is that insurance and cars are similar.  The first customer is really expensive and the second, third, etc. are almost as much.  You need thousands if not millions of customers to amortize the pooled risk (insurance) or the design and setup costs (cars).  Software makes this more so, as the marginal costs get much closer to zero.


Where does capital come from? Sorry if this is a birds and the bees type question.  Where does capital come from?  And I am not talking human capital (which to my mind is skills basically).  I suppose I'm taking about financial capital.

So, I think one can create personal capital by choosing not to consume, i.e. save.  Also I think retained profits are another (and I was wondering perhaps the ultimate) source of capital.

If we look at the capital structure of a company then bank loans, corporate bonds and equity capital are all invested, retained profits are internally generated capital.  External corporate capital, to my mind, comes from household savings.

I know there is the external sector but can we simplify the problem by excluding this?  Let us consider the closed economy only.

I suppose I'm asking for a theory of capital.

I know Marxists have a view and they are welcome to give an updated view (please no re-hash of nineteenth century economic theory, bring it up to date please).

I also think that the Austrian school is critical of Keynesians because the former says the latter have no theory of capital.

Need illuminating in the capitalism facts of life.   Thanks.

I wish there was a tag 'meta-economics' or 'philosophy of economics' to describe this question.

Material capital is any durable good that is used as a factor of production and, by virtue of being durable, it is gradually consumed in production over a maximum possible duration of a length that is determined by (i) how much a unit of capital is used and (ii) the depreciation rate of a unit of capital. Capital forms by labor and savings (which is in accordance with the labor theory of value) and/or capital forms by chance (which is in accordance with the marginal theory of value).

Imagine, for example, a solitary person that is stranded on a tropical island. To stay alive, that person must eat and, on the particular island, imagine that virtually every bit of edible biomass is a coconut. In order to be able to consume any coconuts, coconuts must be produced. Without any tools, this person must climb a palm tree to obtain a coconut and, once back on the ground, then must find a way to crack it open. If the person has obtained enough coconuts to last long enough for the person to take a day off from climbing trees then the person, by virtue of their coconut savings, can afford to leisure. Yet, perhaps the person decides not to leisure and, rather, decides to produce tools (i.e. to labor) to make coconut production easier. Perhaps the person fashions a pole out of bamboo to knock coconuts from the tree so that the person doesn't have to keep climbing trees, which reduces the amount of work required to produce coconuts and, therein, makes coconut production that much more productive by virtue of the bamboo tool, which is a form of material capital (as it can be used repeatedly to produce coconuts, which cannot be used repeatedly). As Abraham Lincoln (1861) once said, "Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed." Yet, capital also forms by chance. To break open the coconuts, the person might use a rock and, perhaps, if there were no rocks on the island that could be used to crack open coconuts then, thanks to misfortune, the person might starve.

Capital cannot be discussed without also discussing tools and technology; they are inseparable. A tool is when capital and a technology coalesce. For example, a makeshift wooden spear is a hunting tool. It is a coalescence of wooden material (capital) and a hunting technology. The wooden object of which the spear is made is material capital, which depreciates at a rate at which the wooden material’s maximum strength decreases. Knowledge about how a wooden object can be used as a spear is a hunting technology. Such technical knowhow is cognitively embodied (in some form or another) in the living body of the tool user, and it is expressed in the body’s behavior, which is behavior that determines how the material object is used (and effectively renders it a tool). This theory has support in the life sciences. (Alfred Marshall [1922] once wrote, “Economics [is] biology broadly interpreted.”)

The phenotype of an organism extends beyond the individual organism, as expressions of an individuated organism’s genes are not contained within that individual organism. Gene expression can be manifest in the behavior of its kith and even in the behavior of another species entirely. “Genes in orchids express themselves phenotypically [as] changes in bee behavior, which result in [a] transference of pollen grains containing those same genes” (Dawkins 1984). The extended phenotype of any individuated organism is the gene expression that extends beyond the embodied physiology of that individual, and it is “less purely biochemical than . . . the conventional local phenotype” (Dawkins 1984).  Among the many kinds of phenomena that can be considered to be of an extended phenotype are artifacts like fabricated shelters and tools. “Caddis larvae live in houses which they themselves build out of stones [or] other material. The form of the house is determined by the behavior of the builder, which is presumably influenced by the builder’s genes” (Dawkins 1984). The genome of a builder is the energetic scaffolding of the behavior of the builder (Hoffmeyer 2014), and such behavior, which is gene expression, determines the form of what the builder builds.

The coalescence of capital and a technology as a tool is a process of semiosis.  A tool is a sign of capital signifying a technology, which is a notion that comes to be more clear in reference to Ferdinand de Saussure’s semiological conception of the (dyadic) sign. The makeshift wooden spear is a sign of capital signifying a technology. The wooden spear is a hunting tool, and a tool is a sign. The wood of which the spear is made is material capital, and capital is a signifier. The knowledge about how the wooden object can be used as a spear is a hunting technology, and a technology is a signified. The wooden spear, which is a hunting tool, is a sign of wooden material capital signifying a hunting technology, and the arbitrariness of the signifier speaks to the old adage that anything can be used as a weapon. Tools are to technology are to capital as signs are to signifieds are to signifiers.

Returning to the topic of capital, material capital extends from human capital (e.g. knowledge, skills, & innovation) and financial capital extends from material capital. Financial capital is part of financial infrastructure, which is a tool by which other tools (and material capital commodities) can be obtained by supplying one's saved income (or positive profit in production) rather than one's labor. Human capital is phenotypic, which means there is a genetic component. As Ronald A. Fisher once wrote, "In organisms of all kinds the young are launched upon their careers endowed with a certain amount of biological capital derived from their parents." (Fisher 1930). Fisher considered the inheriting of household wealth by offspring from their parents to be an extension of a more generalized inheritance process stemming from the inheriting of genes by the offspring from the parents, which is a notion that foreshadowed the Dawkinsian theory of the extended phenotype. Fisher was a protégé of the political economist Leonard Darwin, a son of Charles Robert Darwin. Charles Robert Darwin notably employed the Malthusian population principle from classical political economics (see Malthus 1798) as the architecture for designing his theory of natural selection (see C. Darwin 1860) and, as Karl Marx (1867) once remarked, "Darwin has interested us in the history of nature's technology, i.e., in the formation of the organs [that] serve as instruments of production for sustaining life." Indeed, Charles Robert Darwin's grandfather, Erasmus Darwin, had written of an "Economy of Vegetation" (1791) and, prior to that, Carolus Linnaeus described all life as an "Economy of Nature" (1749). Indeed, "The ultimate subject matter of biology and economics is
one, viz., the life process" (Daly 1968).

NOTE: In answering this question, I've borrowed heavily from two draft works of mine that are on my Academia.edu page (i.e. I have not plagiarized whatsoever): https://independent.academia.edu/AaronHRubin
The following two links are to the two works of mine from which I'd borrowed:

https://www.academia.edu/28416634/A_Brief_Historical_Survey_of_Economic_Thought_and_the_Life_Sciences

https://www.academia.edu/29823064/LifeEconomyEnergyandSemiosis_-_working_paper.pdf

Capital is the potential to create something of value. Humans can make things or do things for other humans by giving their time to a task of value to other humans. So, if I have a 40 hours spare per week, then I have a 40 hours worth of human capital per week. And, depending on the value of the skills I have that human capital could be worth more or less, than someone else's 40 hours. If we extend the concept of potential to create value then we have a concept of capital that is generic. If I have a £1000 I can use that to hire someone or buy a machine that has the potential to generate things of value, and so on.

Hope that helps?


If automation implicitly increases wealth, why is it generally considered undesirable? When it comes to the subject of automation, I read that the wide majority of the arguments assume that the profits/savings "vanish", alongside the jobs loss.

I see the reasoning above as flawed though: if automation lowers the prices of the goods (both by increasing productivity, and by reducing costs; I'm ignoring the automation industry itself) in general, this leads implicitly (in the long term) to an increase in wealth, and by extension (again, in the long term), to an increase of the jobs offer.

In practical terms, if producing, say cars, would cost less, people would save money and spend it through other markets, say going (more) to theater; the increase of demand in other markets would create new jobs, in this case, theater companies.

I see the net of all of this as positive. Am I missing some important factors?

I can see as argument (by some) that this phenomenon could/would only lead to increased profits for the "Top 1% of the evil capitalists©".
Although undesirable, this is irrelevant - such (evil©) people would certainly spend or reinvest the money, again, leading to the mentioned consequences.

It's important to note that I'm talking about long term. I'm sure that if literally tomorrow automation would take over millions of job, it would certainly be a disaster.
I'm also assuming a healthy economy, that is, the increase of savings/profits wouldn't stay still under the mattresses.

Short-term or long-term, Property rights and distributional issues exist, "evil capitalists" or not, and they will always result in strong scrutiny of any change.  Remember that what is "short term" for society is mid- or even long-term for individuals.

Moreover, there exists the transitional pain: whether we can optimize it downwards, and who is going to feel it.

All these cause the heated arguments and the opposing positions.

But your post starts with a strange assertion: that "almost all times" it is assumed that automation has a negative economic impact. If this was so, it seems a little strange that automation marches triumphantly for the last two hundred years, and it continues to do so. If this was so, people now must live in a much worse material situation than two hundred years ago. Is this the case?

Yes.

Right now you can afford to buy a new Tesla 3 for only $35,000 because you are working in Detroit for General Motors.

I don't know how many people work in the factories in the entire world building cars but let's say there 10,000,000 in the entire world doing exactly that.

These are blue-collar jobs and the people building cars have limited skills. Some of these workers have been doing that for decades.

As you probably already, know some auto manufacturers are buying robots to build the cars.

We now have the technology to build an entire car from start to finish without only a few human beings.

Back in the day, it took thousands of men to build a single car. Including the people working at the tire factory and the people working at the window factory and so on.

Now the tire factory is firing people and buying robots.
Now the window factory is firing people and buying robots.

Eventually, all the factories currently selling a product to General Motors will have robots instead of people.

As you can see, these workers cannot  afford to buy a Tesla anymore.

In fact, they could be homesless in the near future.

Most people cannot survive without a paycheck indefinitely.

How long can you survive without a paycheck. Consider the possibility of selling your house, small business, car and everywhere else and drain your bank account.

If the answer is not for the rest of your life then you need to save more and invest more in the stock markets with the help of a professional portfolio manager.


Why does any treasury / central bank hold gold? I know the US treasury is slowly selling its gold reserves, but what is the actual mission and purpose when it comes to the holdings?

What is the reasoning behind the slow rate of liquidation? I have even heard "tradition" and "propping up confidence" as reasons. Tradition doesn't feel like more than an excuse. Confidence or creditworthiness should stem from the expected performance of the US economy and tax collected on that activity, since treasury securities are not backed by gold.

It's a holdover from the old Gold Standards. Gold standard regulation required all banks, including the central bank to hold gold as a regulatory asset. In the last gold standard, the Bretton Woods regime, the US in particular had to hold gold to back the dollar. The requirement went away with the collapse of the Bretton Woods agreement in 1973, but the gold didn't.

These days there isn't any requirement to hold gold, and indeed some countries - notably the UK in 1999 and 2002 have sold off significant amounts of their bank holdings. (Note though, it's been suggested there were stability issues behind this sale.) Gold on the Federal Reserve's book isn't even held at market prices, it's marked to a notional statutory value of ~$42.

By the same token, there isn't any requirement not to hold it, so why sell it? There tends to be a lot of inertia in these kinds of systems.

Interestingly, an examination of central bank annual reports shows a fair amount of variation in what they use for their assets. While government debt in the form of treasuries is usually present, the Norwegian central bank holds market securities - presumably due to a lack of government debt. The Federal Reserve added securitized loans in the wake of the 2007 crash in order to stabilise their financial system.

It depends who you ask and which answers you believe. According to former Chairman Ben Bernanke, its because of "Tradition". However, whether that is the true reason is up for debate. Central banks have a direct interest in making gold seem less valuable, because their motivated to ensure people believe dollars (fiat/paper) is valuable. All fiat currency is constantly competing with gold for value. If everyone stopped creating money demand and started hoarding gold, the central banks would, by definition be useless and powerless. Oddly enough, while they claim it's because of tradition, they sure do hold a lot of it.

Gold, while not used as money today, is an asset class that retains it's value in the long run and is considered valuable in every corner of the globe. Central banks generally hold gold as a "reserve" and delegate a percentage of reserves based on how much paper currency they issue. Additionally, gold is an inflation hedge, so Governments and banks don't suffer as much from the very currency they issue themselves.

Prior to Alan Greenspan becoming Chairman of the Fed, he wrote a fascinating paper about Gold called: "Gold and Economic Freedom" (1966). As one of the most powerful people in the world, this is surely a good read.


Is there a change over the business cycle in how much of economic activity is market-based? Out of the total production in an economy, a big part is market-based, as when you make something and sell it. But a big part is not, as when you make something and don't sell it, but exchange it or use it in some way. Examples of this are home production, cooking, washing, etc, as well as gifts to friends, social service, etc.

More over, the fraction of production that is market-based probably changes over the business cycle.  For example, suppose that, in a recession, I agree to cook for my neighbor every other day because we are both unemployed. He cooks for me every other day. In a boom, instead I get a newly created job which pays me 50 dollars a day, and I by a 10 dollar a day meal from my neighbor who now sells me the food he cooks. The economy is only producing 50 dollars more since we used to produce two meals a day and now we are producing the same two meals a day plus 50 dollars. However, because I pay for the 10 in food, it seems the economy is producing 60 dollars more instead of just 50.

Other things that happen in recessions that don't count as output: when you are unemployed, you fix your house, you make art, etc. Maybe businesses give away more goods and services because they have the installed capacity, but not the demand...

Is there a way to measure the size of this effect?

Yes, the two figures are different because that is how the economy works in a circular flow. To calculate the size of economy (GDP), we will find the total expenditure, total income or total production. In theory, all three calculations should converge at the same figure. However, in economies they may give different figures. It is a fault of whole concept of GDP that it does not take into account any transaction for which there is not a market price available. So, no matter how much gardening you do at your home, you are not adding up anything in the economy. So, whatever mutual understanding you have with you neighbor and whatever transactions you make, it won't be considered.
In the second part of your example, you are spending 10 dollars and your employer is spending 50 dollars so that add up to 60 dollars. This happens because of circular flow, your income is somebody else's expenditure.

Production for which there is no price will not be counted.


What is the opportunity cost of doing something in your spare time? My university is using this textbook. The text clearly states, “Economists use the term opportunity cost to indicate what must be given up to obtain something that is desired.”

This leads me to believe that if you are a salaried worker who makes 50 dollars per hour and works a standard five-day workweek, the opportunity cost of you mowing your lawn during the weekend is 0 dollars. You are giving up your unpaid free time to mow the lawn. When I brought this up in the online discussion I was told by the instructor, "the cost of your free time is estimated using your wage rate."

Is free time = wage rate just the standard convention? This hardly seems appropriate since you aren't giving anything up other than your free time. The situation would be different if you were giving up weekend work to mow your lawn.

There is a crucial detail missing in the scenario you describe.  Is the worker working a five day week (and no more) because that is what their terms of employment require?  Or do they have the option of doing additional paid work (at the same rate, and for as many hours as they wish) at weekends, but on this occasion have opted to work only five days in the week?  If the latter, then it is clear that the opportunity cost of mowing the lawn is the value of the time taken at the wage rate.

If however, the worker's paid work is limited to five days in the week, then it is not paid work that is being given up in order to mow the lawn at the weekend. Although the concept of opportunity cost seems clear enough, its application in this situation can be quite difficult, because it may be hard to identify what exactly has been given up. Suppose (as suggested in the comment by 1muflon1) that an alternative use of the time was to watch a movie. Fleshing out this scenario, suppose that late on Sunday afternoon, the worker was just about to watch the movie, but suddenly noticed that the grass was getting long, and decided that it couldn't be left for another week, so instead went to mow it. So far, it seems that what has been given up is watching the movie. But suppose that, having mowed the grass, they decide to watch the movie in the evening, displacing some other activity.  Rather than a clearly identifiable alternative that has been given up to mow the lawn, there may be a whole series of activities, each of which has merely been slightly postponed to give priority to another.

A context in which economists make use of the opportunity cost of leisure time is the travel cost method for estimating the value of non-market environmental goods such as parks. In this context the value of leisure time has often been taken to be a fraction of the wage, an influential source explaining the basis for such an assumption being Cesario (1976).  Use of a fraction of the (average) wage can be a pragmatic way to avoid the complexity of identifying what an individual has given up, and for aggregation over individuals in different circumstances.

Reference

Cesario, F J (1976) Value of Time in Recreation Benefit Studies  Land Economics 52(1) Feb 1976 pp 32-41

If you mow the lawn, you give up time on the couch, not time at work. So the opportunity cost is zero.

Or, you could pay the neighbor boy to mow your lawn. So the opportunity gain is his salary, which makes opportunity cost the negative the gain.

If you pay him 10 Dollars to mow the lawn, your opportunity cost ist -10 Dollars.

And, now lets calculate the cost of going to the gym you avoid paying by mowing your lawn .. ;-)


Is the labor force participation rate related more to labour supply or to labour demand? Or both? I have read several Labor Economics books, but I am stuck. Is the labor force participation rate related more to the labour supply or to the labour demand?

If the labor force participation rate decreases in a year (with respect to the previous year), should we worry that employers are not hiring (i.e., labor demand)? Or, is it due to workers that are not currently interested in work (i.e., homemakers)?

Furthermore, from this and this online documents it seems that the LFPR (labor force participation rate) is strongly dependent on labor demand from employers (i.e., positive/negative business cycles) rather than from labor supply. For instance, the LFPR dropped strongly during the Great Recession as employers were not willing to hire workers. Any opinion on these problems?

Traditionally, labor force participation is best thought of as a supply-side phenomena. That is, a certain subset of our nation's population is jobless but is jobless by choice. For example, consider a stay-at-home parent. So, we have agents making a decision to not supply labor.

However, there is a hint of the demand side at play here. For example, a very weak demand side might discourage workers, thereby compelling the marginal participant to exit the labor force.

So, to be explicit: LFP is a supply-side concept. However, there is a mechanism through which demand side forces can factor into LFP.


if the richest 85 people give away all their money? I once heard a fact that the richest 85 people are as wealthy as half the world's population put together. My question is, what does that mean?

Does it mean that there is some feasible method in which these 85 people can double the wealth of half the world's population? What would happen if they decided to do so? How would they go about doing this?

It seems safe to say that the bulk of that wealth consists of equity (stock) holdings, not "money." (For example, Bill Gates owns a lot of share of Microsoft.)

Let's assume that the top 85 people wanted to redistribute their wealth voluntarily.

If they tried selling that equity all at once, the price of the equities would likely collapse (who would pay a lot of money for those shares, if everyone know that they were selling all at once?) The amount of money to redistribute would be a lot less than the current estimate of their wealth (which uses the current stock prices). The logistics involved with the transfer would probably consume most of of the transferred wealth. (If it were easy to transfer wealth to individuals in poorer countries, aid programmes would have been more effective than seen in practice.) That is, some people would be wealthier, but it would likely be intermediaries skimming off the cash transfers.
Logistically, there would be no way to transfer all of those shares to half the world's population. (They would need something like a brokerage account.) And even if that were somehow accomplished, the recipients would likely dump their shares, and their value would collapse. Brokers would probably end up getting all of the value from their transaction fees.

In other words, there would presumably be a transfer of wealth, but it would be a lot less than what is implied by current market prices.

This of course raises the obvious question of why they would do this voluntarily; the top 85 richest people did not get that way by dumping their wealth on random strangers.

There a no realistic expectations of doing this and nor a technical way of doing it, because every people on earth dont have a bank account or in age to have it.

No they don't double the wealth of every of them, they hold the same amount of wealth. If they would give it would be not well distributed.(fairly)

If they give to the haft of the humanity with no strategic distribution nothing will happens. Poor people always consume n amount of money for they basic needs. So they will spend it. And you would have 85 new poor guys.

They will not like it for the reason just exposed before. They will be no impact at all ( its like having and extra meal for tomorrow). That why development is so crucial and smart investment too.


Stimulus (Rescue) Package With regard to the recent 2 trillion dollar coronavirus package, is the money just being printed or borrowed? A gentleman from the tax payer union claims the taxpayer will eventually be on the hook.

If it is borrowed and budget deficits become a problem then the Fed will step in anyway.

The USA situation is the same as with the BoJ, which helps fund a Japanese 250% debt-gdp ratio: the Fed's profits are donated to the govt anyway. Purchasing govt debt with printed money essentially cancels the debt as any returns paid on the bonds are donated back to the govt.

The 2t coronavirus package, unless a vaccine is found, will not nearly be enough to stop a depression. Helicopter drops will be needed for at least the next 6 months. However, the US only has about 110% (?) debt-GDP so it can easily afford another 20t stimulus before it even approaches Japanese debt levels.


Multiple Forgone Job Opportunities and Economic Profit I'm told that forgone job opportunities are implicit costs, to be included in calculating economic profit, but I can't seem to see how I could list and consider many different forgone opportunities. My question here is how do we do so?

For example, if I have a piece of land or big city real estate, there could be a great many different uses for it. If I considered each of these forgone opportunities an implicit cost, I would think the expression of my economic costs would be useless to me.

So I suspect that either I'm suffering from an oversimplified ECON101 explanation of implicit and opportunity costs or simply an incorrect one. Any references would be appreciated.

We don't use all possible opportunity costs. We only use the cost of forgoing the next-best-alternative.


Price discriminating monopolist question A price discriminating monopolist sells in two markets. Inverse demand in market 1 is given by: $$P_1(Q_1) = 80 - (1/2)Q_1$$ and inverse demand in market 2 is given by: $$P_2(Q_2) = 100 - Q_2$$ The monopolist's cost function is $C(Q) = (Q_1 + Q_2)^2$
a. Formulate the monopoly's function as a function of $Q_1$ and $Q_2$.
b. Calculate the monopoly's profit maximizing quantity sold in markets 1 and 2 and the corresponding prices.
Now suppose the government forbids price discrimination, so the monopolist can only set a single price for the two markets.
c. Compute the monopoly price and quantity.
d. How much is sold in market 1 and market 2, respectively?
e. Was the government intervention beneficial for social welfare or not?

a. This one is straightforward. $$= Q_1(80 - Q_1/2) + Q_2(100 - Q_2) - (Q_1 + Q_2)^2$$
b. This one I believed to be straightforward - set MR = MC. Thus, $$MR_1 = 80 - Q_1$$ $$MR_2 = 100 - 2Q_2$$ $$MC_1 = 2Q_1$$ $$MC_2 = 2Q_2$$ which gives $$(Q_1, Q_2, P_1, P_2) = (\frac{80}{3}, 25, \frac{200}{3}, 75)$$
c. This is where I start to get a bit messed up. Setting $P_1 = P_2$ gives a total demand function $$Q_1 + Q_2 = Q = 260 - 3P$$ I then solve for price, and get $$MR = \frac{260}{3} - \frac{2Q}{3}$$ and $$MC = 2Q$$ Thus, I'm left with $$(P,Q) = (75.8333, 32.5)$$

However, I feel as though I must have made a mistake. The profit when the monopolist is able to price discriminate actually ends up being lower than the profit when limited to one price. This surely can't be the case - where is my thinking going wrong here? Is my methodology off?

MC = 2Q1 + 2Q2 for both demand functions. Set MR1 = 2Q1 + 2Q2, and MR2 = 2Q1 + 2Q1 and then you have a system of 2 unknowns and 2 equations. The solution ends up being Q1 = 15, P1 = 72.5, Q2 = 17.5, P2 = 82.5. In this case Profits under PD > Profits Under single price. See you in 468 tomorrow.

I think if the government prohibits price discrimination, then the sum of MR in each market should equal to the MC: $$2(Q_1+Q_2) = 180 - Q_1 - 2Q_2$$ Also the price in each market should be the same: $P_1 = P_2$. Therefore:
$$ 80-Q_1/2 = 100-Q_2$$. Aligning these two equations we get $$Q_1 = 20; Q_2 = 30; P_1=P_2 = 70.$$ Hope this helps!


Does a price on the demand curve represent the highest or lowest price the consumer is willing to pay? My question comes out of the context of the explanation for quotas in the textbook Macroeconomics, 4th edition by Paul Krugman. The explanation is for what could've happened had a quota on cab rides not been placed. In this explanation, the price of $5.50 is apparently the minimum price consumers are willing to offer:

  Looking back at Figure 4-8, you can see that starting at the quota
  limit of 8 million rides, New Yorkers would be willing to pay at least
  $5.50 per ride when 9 million rides are offered.

In the next paragraph, there is another reference to the price as being the minimum that people were willing to pay:

  The same is true for the next 1 million riders: New Yorkers would be
  willing to pay at least $5 per ride when the quantity of rides is
  increased from 9 to 10 million...

Shouldn't this price be the maximum price that consumers are willing to pay for, instead of the minimum price, as the book suggests? Why would a consumer not want to pay less that $5.50$ dollars per ride, at $5.30$ dollars for example, if the same quantity of rides (9 million) is offered?

I have included a copy of the diagram that is referenced, which I redrew. The x axis is quantity of cab rides per year, in millions of rides. The y axis is the fare price per ride. The green, orange and red lines are the demand, supply and quota restriction lines respectively. Please click to enlarge image.

A distinction must be made between the individual demand curve and the aggregate demand curve.

An individual demand curve (or demand schedule) for a product/service, represents the pairs {price, quantity demanded} that co-optimize the consumer's utility maximization problem (together with all other quantities demanded of the other products that are present in the utility function).
It may appear that then this would be the "maximum" price, but it would be confusing to characterize it like that. Because, if the price changes, what would happen to individual quantity demanded depends on whether the good is normal or not, and in general whether there are "income-effects" or not (not all utility functions allow for income effects, by the way).
Moreover, at the individual level, the concept representing the consumer is quantity demanded, not price: the consumer observes prices and responds with quantity demanded.

Let's move now to the aggregate demand curve. It is simply the sum of individual demand curves for each price. Here we have two alternative approaches:

a) The more "traditional" one is that all consumers have a non-zero demand schedule for all price levels, each lowering its demand as price increases. Here the previous discussion applies.

b) The alternative but equally "standard" approach is to argue that for each consumer there exists a (possibly different) "threshold" price, above which the individual demands zero quantity. So as price decreases, we imagine that more consumers enter the market with non-zero demand, and this is why as price decreases aggregate quantity demanded increases.
This approach implies that the price level in each price/quantity combination is the minimum ("at least") price for some consumers, while others would be willing to pay more (and so they have contributed positive quantity demanded for higher price levels).

I believe this is the approach taken by the textbook.

On an existing demand curve, yes. However, demand curves can move up and down laterally as well. This might be in response to an external shock such as a sudden perception that cabs are the cure for cancer.


Has the world become poorer? This question is not backed by serious economic research but mainly by a very simple attempt to look at how the world economy has changed.

I am asking whether and why the world has, over the past 50 or so years, become less productive (not used in the strict economic sense here) and therefore people have less money to do stuff/buy things.

Several reasons why I believe this to be the case (I am open to be corrected):

Real wages in developed economies have not risen for a long time
Financial crisis now been going on for many years (almost 10)
Unemployment in the EU is very high
Tax rates are ever-increasing (it seems) relative to median wages
More and more people are reliant on welfare (from what I gather, unfortunately I don't have a source at this point
Growth in developing countries (China) has decreased
National debts are ever-increasing

This has left me with the feeling that in many situations, there is simply 'less' money to go around and be spent. I can observe this, for example, by the seemingly constant need of companies and countries (even where I live, in wealthy Switzerland) to save money and reduce expenses (I don't know if it only seems this way because of some biases or it is actually the case).

Again, not sure if this is actually happening or if it only seems so to me (Also apologies for not being able to express this in very 'economy' terms).

Several reasons that I could explain to myself why it would seem like we have less to spend and are less productive than we used to be:

Rising inequality (the rich keep getting more so the majority has less)
Less incentive for technological progress (apart from in IT). In many industries, there is no reason to keep making everything better, only to make it cheaper and more profitable. We have most of what we need and don't see a point in improving it (cupboards, beds, kitchen utensils etc.)
Lethargy of people. Many people are happy with what they have and do not want to work more/harder
We have most of what we need, and the things that are left to buy are luxury items (which we maybe didn't think about before)

Again sorry for the very vague way of asking this question without any evidence, but if someone could help me make it more concrete I would be very open to that.

I guess what I want to say is do people have less money and less to spend than they used to, and if so, why?

The short answer is No.

Every single year, except 2009, for the past 55 years of continuously recorded economic history, the world has been getting richer. The -2.1% global recession in 2009 was made up in 2010 with 4.1% growth. I was just working with the World Bank's World Development Indicators, which track global GDP growth, and I double checked.

We measure prosperity and growth by the quantities of goods produced. Money is irrelevant. Every year we, humans, produce more and more goods and services and that makes us richer. Not every country grows steadily though. Some countries are stagnant, like Greece, and some grow remarkably rapidly over very long periods of time, like China. Moreover, there is increasing inequality withing many countries (measured by GINI coefficient). So it is very natural for many to feel like everything around them either stands still or degrades. But on average, the world keeps getting richer.

If you are in Switzerland, you may have felt the shock from recent currency appreciation. Sharp currency appreciations hammer exporters and industries reliant on tourism, which make up a large portion of Swiss economy.

Rising inequality (the rich keep getting more so the majority has less)

This is false. What do rich people do with their money? They invest. Investments stimulate business. They start companies. They buy million dollar homes that provide jobs for construction workers. They own companies that employ thousands. They buy 4k TV's and similar expensive products which gives companies the capital to begin producing things on a large scale.

The richer the rich people are, the better for us. Take more rich people and richer people as a sign of an improving economy, not a poorer one.

I recommend Basic Economics, by Thomas Sowell. It'll give you a great idea of how economies work.


Is there a formal definition of opportunity costs, economic costs, and/or economic profits? [Edited to remove a mistake in a definition and some typos.]
According to various econ textbooks (e.g. this one), there is a fundamental distinction between economic profit and accounting profit:
(i) While accounting profit subtracts only explicit costs (out-of-pocket costs) from revenue,
(ii) economic profit subtracts opportunity costs, also known as economic costs, which consist of explicit and implicit costs. Here,
(iii) opportunity costs are generally defined as the "value of the best foregone alternative". In the context of firms, "value" of course means profits.
(iv) Furthermore, when economists talk about "costs" and "profits", they always mean economic costs and economic profits. For example, firms are assumed to maximize economic profits.
All the definitions I found were verbal and informal as above. Is there a formal definition of these concepts? Do they make sense at all? Since I didn't find anything in the literature (by a quick search, admittedly), I tried to formalize it myself for the firm context:
Let $X$ be a set of alternatives the firm can choose from, and let $z\in X$. Let's assume that alternative $z$ yields revenue $r(z)$ and generates explicit costs $c_e(z)$ for the firm. Accounting profit $\pi_a(z)$ is defined as revenue minus explicit costs, so $\pi_a(z)=r(z)-c_e(z)$. Economic profit $\pi_e(z)$ is then defined as accounting profit minus implicit costs $c_i(z)$, thus $\pi_e(z)=\pi_a(z)-c_i(z)=r(z)-(c_e(z)+c_i(z))=r(z)-c_o(z)$.
Opportunity costs of choosing $z$ are the value of the best foregone alternative, so $c_o(z)=\max_{k\in X,\,k\ne z}\pi(k)$.
Now, what is the "profit" $\pi(k)$ here? Economic profit or accounting profit? This might not be immediately obvious. Let's have a closer look.
Finite sets of alternatives
Assume for simplicity that there are only two alternatives, $X=\{x,y\}$, with $r(x)>r(y)$.
(i) Let's try economic profits, so $\pi(k):=\pi_e(k)$:
Then $c_o(x)=\pi_e(y)$ and $c_o(y)=\pi_e(x)$.
Therefore $\pi_e(x)=r(x)-c_o(x)=r(x)-\pi_e(y)$. Now, analogously, $\pi_e(y)=r(y)-c_o(y)=r(y)-\pi_e(x)$. Substituting, $\pi_e(x)=r(x)-r(y)+\pi_e(x)$, implying $r(x)=r(y)$. This is a contradiction, so this approach makes no sense.
(ii) Let's interpret "profit" as accounting profit, i.e. $\pi(k):=\pi_a(k)$.
Then $c_o(x)=\pi_a(y)$ and $c_o(y)=\pi_a(x)$, so $\pi_e(x)=r(x)-c_o(x)=r(x)-\pi_a(y)=r(x)-r(y)+c_e(y)$. Similarily, $\pi_e(y)=r(y)-c_o(y)=r(y)-\pi_a(x)=r(y)-r(x)+c_e(x)$. This is at least not contradictory.
Infinite sets of alternatives
But there are rarely only two alternatives. Consider instead a standard quantity-setting monopolist. The set of alternatives is the set of quantity choices, so $X=\mathbb R^+$. Let's denote by $q^*$ the firm's optimal choice. Then the firm accrues accounting profits denoted by $\pi_a(q^*)=r(q^*)-c_e(q^*)$, where both $r$ and $c_e$ (and therefore $\pi_a$) are assumed to be continuous. What is the firm's economic profit $\pi_e(q^*)$ then?
Well, the firm's "(accounting) profit from it's best foregone alternative" is the accounting profit resulting from the smallest strictly positive deviation from $q^*$, which, unfortunately, doesn't exist. To the rescue, let's interpret the "(accounting) profit from the best foregone alternative" as the supremum (instead of the maximum) of the foregone accounting profits: $c_o(q^*)=\sup_{k\in X,\,k\ne q^*}\pi_a(k)$. This, however, is just $\pi_a(q^*)$. Then $\pi_e(q^*)=r(q^*)-\pi_a(q^*)=c_e(q^*)$.
Economic profit of a profit-maximizing monopolist being equal to its out-of-pocket costs? This seems not to make sense.
So do the concepts of economic profit and opportunity costs as defined in (i)-(iv) make sense at all? Or which of (i)-(iv) above is wrong? Or is the "value" of the best foregone alternative in the context of firm decisions neither economic nor accounting profit of the best foregone alternative? What else?

Economic profit
I think there are some problems with the formulation in your question, first you heavily focus on opportunity cost but note accounting profit does not even properly capture all revenue firm gets.
I will first focus on economic profit more broadly and at the end go back to opportunity cost.
Following Varian Microeconomic Analysis pp 24 (emphasis mine),

Economic profit is defined to be the difference between the revenue a firm receives and the costs that it incurs. It is important to understand that all costs must be included in the calculation of profit. …
Both revenues and costs of a firm depend on the actions taken by the firm. These actions may take many forms: actual production activities, purchases of factors, and purchases of advertising are all examples of actions undertaken by a firm. At a rather abstract level, we can imagine that a firm can engage in a large variety of actions such as these. We can write revenue as a function of the level of operations of some $n$ actions, $R(a_1,...,a_n)$, and costs as a function of these same $n$ activity levels, $C(a_1,...,a_n)$.

The above is already rigorous definition for economic profit, economic revenue and economic cost.
Note accounting operates under its own sets of rules. Accounting, is not econometrics. Point of accounting is not to accurately estimate or measure economic relationships. So what you are doing above, defining economic profit at simply accounting profit minus opportunity cost is somewhat misguided (it would only hold in an unrealistic special case where we assume accounting only missed opportunity cost but accounting misses so much more).
First, following Varian we can start with a set of occurring actions $a$ that create revenue and costs. However, when it comes to accounting, not all of these will be reported. For example l, consider selling goods without issuing receipt to avoid paying taxes, which will not get reported as accounting profit. The same holds for many costs other than opportunity cost. For example, consider how depreciation costs are treated by accountants. From purely economic perspective most assets definitely do not depreciate in linear fashion yet accounting allows firms to use linear depreciation for most assets regarding what the true depreciation cost each period is. So the accounting depreciation costs will too be different from economic depreciation cost. Or consider the fact that many countries allow small business to just in their accounting declare portion of their profit as cost without actually even proving they actually incurred these costs (this is done in some countries to ease administrative burden for sole traders and similar one person businesses).
Consequently, it makes more sense to rather define accounting profit in terms of economic profit and then work backwards by inverting those functions if you would want to get back to economic profit from accounting one.
Call $A=(a_1,...,a_n)$.  set of all economic actions that actually occur, and $R(A)$ would be economic revenue from those activities. Now apply some function $\rho$ which tells you based on $R(A)$ what actually accounting revenue is.
So accounting revenue $R_{acc}$ would be:
$$R_{acc}= \rho(R(A))$$
Similarly accounting cost $C_{acc}$, we will have actual economic cost firm incurs $C$ based on set of actions it takes $A$ and then we will have some function gamma that tells us what enters into accounting and what not so we would have that
$$C_{acc} = \gamma (C(A))$$
Finally the accounting profit would be difference between the above so:
$$\Pi_{acc} = \rho(R(A)) -\gamma (C(A))$$
Note what $\rho(.)$ and $\gamma(.)$ are will depend on local accounting regulations and laws. in some country government could declare that any firm has to put  always just 1000€ as their cost (yes it is unrealistic example but I am just showing it to prove a point) and in such case $\gamma(C(A))=1000$ regardless of anything that happens.
Whereas the true economic profit would just difference between economic revenues and economic costs:
$$\pi=R(A)-C(A)$$.
If you would want work your way back from accounting definitions then you could use inverse functions and economic profit calculated from accounting one would be:
$$\pi= \rho^{-1}-\gamma^{-1}$$.
Note the above does not really require definition of opportunity cost since here simply the function $C(A)$ is just some function where we assume that $C(A)$ assigns true economic cost to every action $a_1,…,a_n$, for standard profit optimization it’s completely okay to treat $C(.)$ as a black box and thus you will not really require separate definition of opportunity cost. As a matter of fact note in situation where there are no alternatives like having mana (from the biblical story where it could only be immediately consumed not stored or used for anything else) opportunity cost would not even be part of $C$ but still there would be distinction and disconnect between accounting and economic profit.
For example if we have $C(A)=c_1 a_1+c_2 a_2… c_n a_n$ and if we define $C$ as a function that always assigns true economic cost then you definition $c_1$ includes all economic costs including opportunity cost, but the economic profit, economic revenue and economic costs are still rigorously defined (even if the constituents of costs such as opportunity costs aren’t).
opportunity cost
Next tackling the opportunity cost separately (which can be later used to build function $C$), good places to start are Buchanan (1987) or Alchian (1968). The authors do not necessarily derive rigorous opportunity cost functions but give rigorous verbal definitions on which we can build.
For example, according by to Buchanan (1987) :

Opportunity cost is the anticipated value of 'that which might be' if choice were made differently. Note that it is not the value of 'that which might have been' without the qualifying reference to choice. In the absence of choice, it may be sometimes meaningful to discuss values of events that might have occurred but did not. It is not meaningful to define these values as opportunity costs, since the alternative scenario does not represent a lost or sacrificed opportunity. Once this basic relationship between choice and opportunity cost is acknowledged, several implications follow.

First, if choice is made among separately valued options, someone must do the choosing. That is to say, a chooser is required, a person who decides. From this the second implication emerges. The value placed on the option that is not chosen, the opportunity cost, must be that value that exists in the mind of the individual who chooses. It can find no other location. Hence, cost must be borne exclusively by the chooser; it can be shifted to no one else. A third necessary consequence is that opportunity cost must be subjective. It is within the mind of the chooser, and it cannot be objectified or measured by anyone external to the chooser. It cannot be readily translated into a resource, commodity, or money dimension. Fourth, opportunity cost exists only at the moment of decision when choice is made. It vanishes immediately thereafter. From this it follows that cost can never be realized; that which is rejected can never be enjoyed.

since the opportunity cost is the value of the next best alternative you can rigorously define as follows.
Suppose that for each action that actually was taken in the set $A=a_1,…,a_n$, there are alternative sets of alternative actions (e.g. each $a_i$, has some alternative $b_i$, $z_i$ and so on, and let’s assume that all the other alternatives are mutually exclusive with $a$. Well then opportunity cost of each action $a$ is just value of the next best alternative so if we have that:
$a_i\succ b_i \succ z_i … $
Then opportunity cost will simply be $V(b_1)$ where $V$ is simply just some function that assigns monetary value (or in consumer problem utility to $b_i$).
If you want to then put this value into profit function explicitly then simply the cost function will be some composite function given by $C(a_i, V(b_i))$ (note this is ultimately just function of $a_i$ because the next best alternative necessarily depends on what you choose as $a_i$, so in the end it’s just more complex way of writing $C(a_1))$
I think the above is rigorous even though it’s very simple (of course perhaps the notation I use could be made more precise).

According to economic logic the concepts of profit, revenue, and cost have two components designated implicit (non-monetary) and explicit (monetary).
https://www.texasgateway.org/resource/71-explicit-and-implicit-costs-and-accounting-and-economic-profit

We can distinguish between two types of cost: explicit and implicit. Explicit costs are out-of-pocket costs, that is, payments that are actually made. Wages that a firm pays its employees or rent that a firm pays for its office are explicit costs. Implicit costs are more subtle, but just as important. They represent the opportunity cost of using resources already owned by the firm. Often for small businesses, they are resources contributed by the owners; for example, working in the business while not getting a formal salary, or using the ground floor of a home as a retail store. Implicit costs also allow for depreciation of goods, materials, and equipment that are necessary for a company to operate.

These two definitions of cost are important for distinguishing between two conceptions of profit, accounting profit and economic profit. Accounting profit is a cash concept. It means total revenue minus explicit costs—the difference between dollars brought in and dollars paid out. Economic profit is total revenue minus total cost, including both explicit and implicit costs. The difference is important because even though a business pays income taxes based on its accounting profit, whether or not it is economically successful depends on its economic profit.

Note accounting profit is not necessarily cash profit because the typical business operates on an accrual basis rather than a cash accounting basis.
In regard to the economic concepts of profit, revenue, and cost the basic economic (psychological) concept of barter is that both parties to a trade benefit from the trade by parting with something of value to gain some other thing of value. If there is no concept of economic revenue and profit from barter activity then what is the motivation of each party to part with something of value in trade? Therefore I interpret the word "economic" to mean "social agents experience implicit value judgments".
The idea that "economic value" exists independent of money is rooted in social psychology because if one does not make and recognize implicit value judgments as a conscious social being then there would be no "economic concept" of parties to a trade expressing their revealed preferences by making the bargain. Preferences are concealed or implicit in the parties until they are made explicit or revealed by the behavior of the agents. But behavior cannot reveal any preferences unless the observer infers that preferences motivate behavior.
Accountants make efforts to record value using records as evidence of explicit monetary transactions:
https://www.investopedia.com/terms/h/historical-cost.asp

A historical cost is a measure of value used in accounting in which the value of an asset on the balance sheet is recorded at its original cost when acquired by the company.

Accountants can re-value assets based on some accounting principles for mark-to-market or expert judgment (appraisal value):
https://www.investopedia.com/ask/answers/042315/how-market-market-accounting-different-historical-cost-accounting.asp

Historical cost accounting and mark-to-market, or fair value, accounting are two methods used to record the price or value of an asset. Historical cost measures the value of the original cost of an asset, whereas mark-to-market measures the current market value of the asset.

Everyone agrees that assets have economic value, based on our intuition of implicit value judgments, and that this economic value exists independent of the transaction cost or valuation given to any particular asset. But if the economist wants to express this value in a formal math model then like the accountant he or she must specify a quantity with a unit or perhaps a dimensionless unit.
In a formal math model the explicit profit, revenue, or cost are stated in terms of monetary units and given by some sort of accounting judgment.
In a formal math model the implicit profit, revenue, and cost are stated in units other than monetary units. The economics profession makes this distinction between implicit and explicit items where I infer that the implicit items are characterized as distinct from some subset of the explicit, historic, objectively stated monetary transactions recorded by accountants. If accounting judgment is required to make an implicit item explicit in monetary terms then this introduces subjective judgment into the accounting customs.
According to scientific methods for making formal models one cannot mix units in an equation for addition or subtraction. So one cannot mix the explicit and implicit factors in one equation without converting all terms to a common unit.
So if one wants to make an accounting model then convert the implicit non-monetary factors into factors listed with monetary units and then the explicit model will be adjusted for the estimated monetary value of the implicit factors.
And if one wants to make an economic model then convert the explicit monetary factors into economic value units (I have no idea what those units are or would be) and then the implicit model would be adjusted for the explicit factors. The economist cannot specify a more objective model than the accountant because subjective judgment is required to assign explicit value to implicit value judgments.


Meaning of Exchange rate Does exchange rate of local currency relative to US dollar mean LOC/USD or USD/LOC ?

LOC/USD and USD/LOC are currency pairs. Whatever currency comes first is known as the base currency. The currency that comes second is known as quote currency. For major currency pairs, the format of the currency pair is based on established priority. For example, EUR has the highest established priority and thus is almost always shown as the base currency.

Currency pairs quotes work such that one unit of the base currency can be exchanged for quoted amount of the quote currency (hence the name "quote currency"). For example, LOC/USD 6.25 means that one LOC can be exchanged for 6.25 USD. USD/LOC 0.16 means that one USD can be exchanged for 0.16 LOC.

Whenever people say "local currency relative to US dollar", that usually should be parsed as "[base currency] relative to [quote currency]", and thus it would be LOC/USD. A similar interpretation applies for "local currency quoted against the US dollar" (LOC/USD). Another hint is that most "minor currencies" are quoted against the US dollar.


To profit from rolling, mustn't you be much more bullish or bearish than before? Aren't you likelier to lose money from rolling, e.g. scenarios 3-5 below? How exactly can rolling profit you?

What if you aren't more bullish or bearish than before? What if you surmise that the underlying stock will attain only a certain range of prices, and de/in-crease no further?

I'll brainstorm three cases. Imagine that:

you bought a call. Your underlying asset's price hasn't risen above the spot price on purchase date.

you bought a put. Your underlying's price hasn't dropped below the spot price on purchase date.

In both cases, your call's and put's prices will have dropped, and you've lost money.

your underlying's price de/in-creases beyond the purchase spot price. Then all options' IV may rise. Then even puts at lower strike prices and calls at higher strike prices will cost more.

If markets are efficient, the option premium will equal the expected return on the option. This is independent of the past history of the underlying security.
In order for the past history to matter, you will need to demonstrate market inefficiency. It is possible to demonstrate some market inefficiencies (e.g., the fixed income pricing literature is generally premised on the existence of a term risk premium, the issue is how to estimate it). However, future returns getting a risk premium based on recent historical price movements would be equivalent to proving that technical analysis can reliably outperform (on a probabilistic basis). Finding validation of such a possibility has been a major challenge for researchers.

What if you surmise that the underlying stock will attain only a certain range of prices, and de/in-crease no further?

I am not familiar with options trading, however, based on your question I offer the following information. Stock market investor William J. O'Neil wrote a book called How To Make Money in Stocks. In this book he says those who are new to stock market investing should focus on how to buy, hold, and sell growth stocks in a short term portfolio and should look for index investment strategies in a long term portfolio. Stay away from options, margin, and shorting strategies until one becomes proficient at predicting the direction of prices on the underlying investment positions. If your investment theory gets market direction wrong then it will produce a loss in the portfolio. Money management means cutting losses short and letting winning trades run for large gains.
One investor had a friend who plays poker. He asks, "Why am I better at investing while you are better at poker? His friend says, "You think poker is a card game." In poker you fold with a weak hand to keep losses small, bet more aggressively with a stronger hand, and learn how to read and intimidate the other players with betting strategies. The objective of active investing and poker is to gain more from winning big and don't donate too much funds to the gains taken out by the other players in the game.


A world with total automation I was wondering. Suppose that in the whole realm of economic activities, all those activities were fully automized. From the finding of raw resources to the making of products that leave the factories, so the owners of the companies that perform the many tasks from resources to end-product don´t need employees anymore; the maintenance of infrastructures; social- and health-care; in short, every kind of work were we need in this time people for (I´m aware it´s rather far fetched, but often when you push things to the limit some things can become clear).

Would the world be a place of milk and honey, or will conflicts arise?

I would strongly recommend you to read Erik Brynjolfsson, Andrew Mcafee et al for some serious and real insights about this topic. The world economic forum this year had the same theme.
In my view (which are heavily derived from the works of the above mentioned dignitaries) the problems arising from complete automation will be the lowering or stagnation of income levels. As Erik mentions in his Ted talk, productivity levels are at all time high but income levels are not. This was not the case in previous technological revolutions. People and systems adapted to new technologies and income rose along with productivity. Now they don't share the same relationship. One of the reasons is that we are not changing our systems well to absorb the technology. For example, if people are saving a lot of time because of automation, they should be able to spend it in something constructive. May be entrepreneurship, maybe knowledge work. To make all those automation work, people are required to program, design, develop and create. There needs to be a shift from typical work to knowledge work. If such a shift is not there and that too at a speed that matches with the speed of technological changes then income levels will continue to fall, unemployment will rise.
In Andrew Mcafee's words, "we need to RACE WITH THE MACHINE".

With TOTAL automaton, the greatest issue would be that nobody would be working, and the rich would own all the production capacity, so nobody else will earn any money to buy from them.  Effectively, overall demand would dry up even as people are desperate for the things they need, but can't afford to buy even at lower and lower prices.  Even the wealthy would lose out, because there would be no consumers left able to buy their stuff.  Essentially, the economy would grind to a halt unless wealth redistribution was forced by socialism, so that more people could afford to buy things.

To some extent we are already starting to see a shift in this direction, with increasing automation, ever more skewed wealth distribution, and slowing growth and demand as the masses can't afford to buy what they need, even though it can be produced more easily.  The picture won't pretty if nobody can earn a living without any income.

However, that is only the case with complete automation, where there is literally nothing left for people to do.  In practice, simple repetitive tasks tend to get automated first, leaving people with more time to perform more complex tasks that cannot (yet) be automated, and so overall productivity and efficiency increases without impacting overall employment.  So people are still earning a living wage, and they can buy more things that are now cheaper and easier to make.

Automation really only becomes a problem when even the most complex tasks can be automated, and that is the great risk of artificial intelligence that people like Stephen Hawking say will spell the end of the world.  In my view he's probably right.  Not because machines will consciously take over the world, but because they will make people and employment (the potential to earn a living) redundant.


max{x1,x2} where P1not=p2 I have seen min{x1,x2} functions representing perfect compliments but have never seen a max{x1,x2} function anywhere in my book or lectures, I also have never seen anything about p1 not equaling p2. can anybody give me some insight to this problem.

Consider a consumer with a utility function U = max{x1,x2} the consumer faces prices p1 and p2 for goods 1 and 2, respectively, and has an income of m dollars. (assume throughout p1 dne p2).  His optimal consumption solves the standard problem.

a)Find the optimal levels of consumption for goods 1 and 2 as a function of income and prices.
b) is good 1 a normal good?
c) Are goods 1 and 2 complements or substitutes?
any help would be much appreciated

Here is my suggestion:

I would say the optimal level of consumption is $\frac{m}{p_1}$ if $p_1 < p_2$ and $\frac{m}{p_2}$ if $p_2 < p_1$. So the individual consumes only whichever good is cheaper. Since utility is just the maximum of whichever two amounts you could consume, you would maximize that by consuming the highest amount possible.
Good 1 is a normal good if it is cheaper than Good 2, then the amount consumed rises with income.
I would say these goods are perfect substitutes, since you consume as much of the cheaper good as possible with no further constraints.
EDIT: This wrong, they are not perfect substitutes, since they are not substitutable - if you consume only Good 1, you wouldn't want to exchange any for Good 2, except if you then had more of Good 2 than of Good 1.


Why aren't house prices included in CPI? Swedens central bank recently lowered their prime rate to -0.25% from -0.10% in an effort to avoid deflation.

At the same time, house and apartment prices are higher than ever, up 11% last 12 months, and up hundreds of percents the last 5-10 years. Measures are taken to avoid a housing bubble, like regulations on mortgage payments and so on, these are having an effect but the effects of a rapid rise in rate would be disastrous.

As I've understood, and I guess this might differ from country to country, the measure of inflation, CPI, includes prices for services and goods, but not for houses and apartments, why is that? In Sweden, rent for apartments and the bank rate are included in CPI, but the consumer isn't paying rate, they pay rate * house prices.

If house prices were included in CPI, we would definitely have inflation rather than deflation, so the right action would be to increase the prime rate, which would also lower house prices.

The CPI stands for a Consumer Price Index. As in the price of things that are consumed (at a particular moment in time). Real estate prices are not the price of something consumed because they contain the value of current housing consumption but also the capitalized value of future housing consumption. As such, including house prices would make the CPI a mixture of consumption at different times, and therefore unsuitable for comparing the price of consumption bundles at distinct times. Instead, they use a purer measure of the price of housing consumption: rents.

Rents reflect the price of consuming a flow of real estate services at a moment in time. Of course, many homes are owned by the occupants and not rented. Therefore, the calculators of national accounts generate something called "owner occupied rents", which is an attempt to calculate what the rents would be on homes that are occupied by their owners. This measure has problems, but for many purposes is quite adequate (Crone, Nakamura, Voith (2004)).

Experts argue that "raw" (i.e. the cost of actually purchasing a home) should never be included in CPI's because homes are not viewed as something people buy on a regular basis.

But that argument really becomes unstuck when you factor that reserve banks around the world use (WRONGLY in my opinion) CPI to determine interest rates.

The largest purchase for many people across the globe that relate directly to interest rates, is not shares, businesses, cars or any other similar investments, but homes. So it affects the prices of homes and their affordability directly through the setting of interest rates (remembering people need to borrow to buy a home in 99% of cases) and yet these same institutions and their simple minded economists refuse to take into account the growth of the same home prices when determining interest rates.

Inflation in real terms should be a measure of everything purchased in the economy whether it be a home, investment or bread.

Otherwise you have ridiculous situations globally as we have now where the indicators most economists use blindly are saying we have negative inflation, so interest rates are dropped and house borrowing and house prices go through the roof. If a housing market goes up 20% per year in some countries then should this not be included in the inflation rate? Because if house prices were included interest rates would be on the way up and not down.

We are currently being told by the "other" experts without vested interest in banking or housing sectors that the biggest problem in todays global economy is low interest rates fuelling asset bubbles (the biggest being residential housing in many countries). One way to fix this problem and easily is to start including house prices into CPI's and not burying our heads in the sand with ridiculous arguments as why not too. Yeh sure those in recent times who borrowed to much in a bubble asset class will take a massive hit. But it is a massive hit for the few that needs to happen for the better of the many in the medium to long term.


How do I quantitatively visualize this situation? Imagine a case where an average of 10% of the income of the people in a certain country is spent on petrol(gas). Now someone comes up with an invention, say a DIY unlimited power source which anyone can make for practically nothing. Obviously the price of oil will fall. But apart from that, how are the other economic indexes going to be affected? Will GDP rise or fall. What kind of parameters of the country will be affected?

Two things will happen:

Firstly, everyone will effectively have had their real incomes rise by 10% (assuming this new energy costs nothing). They will then spend or save this income on other goods besides energy, increasing overall output (note, savings is used for investment as well).

Secondly, energy consumption will likely increase by a large amount now that it is nothing. People who were mindful about their energy consumption due to cost concerns will now not care. Therefore, people will be consuming more energy.


Did a similar property boom take place in another country or throughout history like we have seen in London? If so how did it effect the economy? The London property market has seen a sharp increase in the average house price. If we go back to the 70's the average UK and average London price were almost the same, however since than the gap has increased quite dramatically. The average property in London is +£400k, whereas in the UK this is almost half.

How long prices will increase till the bubble will burst? Some say property prices tend to double every 8 years, if that's the case then in few years time the average price will be £800k, however this is not a fair balance compared to the average salary in London. My question whether the world has seen a similar property boom like in London (throughout history) where there is an imbalance of property prices & income, prices shooting up to such an extend that they become unattractive/ unaffordable? If so it would be nice if you could provide some reference as I am interested to study this into more detail and understand what the effects were of such highly priced market and how the economy responded?

According to the ONS the house price-to-earnings ratio was 12.8 in London and 7.8 in England as of 31/12/2019.
According to Schroders the house price-to-earnings ratio in England was consistently above 8 until the late 19th century (see graph below). In 1845 it was 13 in England, so it was arguably higher than that in London at the time.
What I don't find very clear is if Schroders are referring to housing units when they speak of houses. They say that "houses" where bigger in the 19th century and hence more expensive. Obviously the average earner did not live in a bigger house but would have shared it with other average earners.
A more sensible statistic would hence be something like a "minimum housing unit price-to-earnings ratio". Comparable prices would still likely be higher in the past. But it shows that creating comparable data would require in-depth study not just of the economics of housing but also how these houses are used, i.e. what can realistically be considered a minimum housing unit in the 19th century given the housing conditions at the time (Engels published The Housing Question in 1872).

Source: Schroders (30/01/2020)


Why is there less price transparency in some industries (especially healthcare) than in others? To give a specific pair of contrasting examples:

If I search for homes for sale in say Michigan, I can quickly see the listed price for each home. (See e.g. Zillow.) Sure, there might be taxes, commission, fees, discounts, etc., but the final price I pay will almost certainly be within ±50% of the listed price I see.
But if I search for an assisted living or adult foster care home (for the elderly) also in Michigan, I am unable to find a single home that lists any price on its website, Facebook page, or anywhere else. Instead, every single home asks you to call or email them, or arrange for a tour. I have no idea what I'll have to pay, even very roughly, perhaps not even to an order of magnitude. I truly have no idea if the cost per month will be \$1,000, \$5,000, or \$10,000.

Unfortunately, from my brief search, there doesn't seem to be much research by economists on this topic (but let me know if I'm mistaken).

Here are some possible explanations I've considered:

Price transparency tends to be decreasing in price.

This might be generally true, but fails to explain why there is so much less price transparency in healthcare than in real estate.

In healthcare, there is much more uncertainty and variation as to what each patient will end up costing.

But each healthcare facility does have standard rates for particular items, such as "a standard type X blood test", "a brain MRI in Machine #566", "a 24-hour stay on Bed #125", "a month's long stay in Room #351" (excluding all miscellaneous costs). Just like any restaurant or business has standard rates for particular goods and services.

The difference is that most restaurants and other businesses do publish these prices, while healthcare facilities do not.

Why is it advantageous for healthcare facilities to keep these prices shrouded in secrecy? Why have market forces not forced them to reveal these prices (in contrast to other industries)?

The US healthcare industry is perhaps exceptionally egregious. But I think it is also generally true in most countries that there tends to be much less price transparency in healthcare than most other industries. Why is this?

Please note that any successful explanation must explain why there is less price transparency in some industries (especially healthcare) than in others (real estate, airfare, food, cars, car repair, university tuition, etc.).

Obviously nursing homes are a.smaller market...

Large, liquid markets with frequent buying and selling of standard products have the most information.

Also, Zillow is bad, home assessors exist for a reason.


Calculating Service Contributions to GDP Trying to get some clarification on how GDP is calculated for service industries.

Are input resources netted out (e.g. fuel for an airline), the same way wheat would be for a loaf of bread?

What about investment assets (e.g. airplanes for an airline) -- these get fully counted toward GDP the year they're purchased?

Services will be calculated at the final price they are given in market. That price includes all value added items in providing the service. So, to calculate contribution of airlines in GDP, you just need to sum up the total value of tickets that are sold. Other things will automatically be counted in that.


Why do people think a stock should have a certain price based on the company's revenue? Stock investment comes part and parcel with discussions about quarterly earnings, P/E ratios, and a host of other considerations designed to measure the "intrinsic value" of a stock and whether it "should" go up or down, or predict future prices based on whether the company is growing/shrinking.
Considering only stocks that don't offer dividends:
Why do investors care about P/E ratio, revenue, or any other company revenue/growth metric? If a stock is worth what people are willing to buy/sell it for, why are investors making their buy/sell decisions based on metrics that don't affect anyone outside the company?

If the price is too low (relative to any metric, be it earnings, growth, etc.), then anyone can profitably launch a takeover/acquisition bid.
Example. A company has 1B shares each priced at \$1 (so market cap is \$1B), pays no dividends, and earns \$100B (profits) per year. Then one could buy up all 1B shares for \$1B, own the company entirely, and enjoy \$99B in profits in just the first year alone.

Here is what Warren Buffett says about intrinsic value:
https://www.youtube.com/watch?v=7NiVg2xLP7U
The generic answer is "discounted cash flow analysis" with uncertain cash flow projections and choice of discount rate. The longer the time horizon the more cash flow uncertainty and the less sensitive the analysis to choice of discount rate.
In this answer Buffett says Berkshire Hathaway does not issue dividends. So the profit strategy for a Berkshire investor is a future sale in the secondary market for a capital gain.
https://www.kiplinger.com/slideshow/investing/t052-s001-9-highest-yielding-warren-buffett-dividend-stocks/index.html

Berkshire Hathaway (BRK.B) famously doesn't pay dividends – it has better things to do with its shareholders' cash – but Chairman and CEO Warren Buffett sure loves collecting them. ... The great majority of the stocks in Berkshire's portfolio are dividend stocks.

Warren Buffett describes the distinction between investment decisions based on business models and the loose connection to secondary market prices in this two hour interview with the Financial Crisis Inquiry Commission:
http://fcic.law.stanford.edu/interviews/view/19
One feature of markets I did not understand prior to the global financial crisis is that debt deals in money and credit markets drive up the valuation of assets and equity (book value of equity is the difference between asset valuations and outstanding debt). So if there is a crisis in money and credit markets, such as during the Great Depression or Great Recession, asset valuations plunge along with the book value of equity. Because fear is more compelling than greed the equity valuation on secondary markets plunges rapidly in a financial crisis.


Proper definition of extensive form game Consider the following game: Let $N := \{1,2,3,4\}$ denote a set of agents.
Going from 1 to 4 each agent can decide how many of the remaining agents he wants to integrate into a coalition.
The strategy sets are given by $S_1 := \{1,2,3,4\}$, $S_2 := \{1,2,3\}$, $S_3 := \{(1,1),(1,2),(2,1),(2,2)\}$ and $S_4 := \{(1,1,1)\}$.
I want to generalize the game for  $|N| = n$. So basically agent 1 picks a number $s_1 \in N$. Then agent $1 + s_1$ picks a number $s_{1+s_1} \in \{1,\ldots,n-s_1\}$ and so forth. Eventually there exists an agent who integrates all the remaining agents $\exists j \in N : s_j = 1+n-j$.

What's a proper definition of this simple game? What are the strategy sets?

Let the set of players be $N=\{1,\dots,n\}$.

According to my understand your description of the game, I take the following statements to be true:

Each player chooses a number of players to integrate, not players with specific identities. As a result, the player making the choice may or may not be included in the coalition.
Each player has to choose at least 1 player, if still available.
Each player moves exactly once.
The game is with perfect information.

Under the above interpretation, player $i$'s ($i\ge2$) action space would be $A_i=\{0,1,\dots,n+1-i\}$, as, in principle, $i$ could choose at most $n+1-i$ other players (when all players $j<i$ chose $1$) and at least $0$ (when all previous players have exhausted the player list). An exception applies to the first player, where the option $0$ is not feasible. Thus $A_1=\{1,\dots,n\}$.

Player 1's strategy space would be $S_1=\{1,\dots,n\}$. Player 2's would be $S_2=\{1,\dots,n-s_1\}$, since after $s_1$ players are picked by player 1, there are only $n-s_1$ players left to be picked by player 2. Carrying this argument forward, player $i$'s strategy space would be $S_i=\{1,\dots,n-s_1-\cdots-s_{i-1}\}$.

Generalizing from the above reasoning and taking into account boundary cases, let history at stage $i$ be $h^i=(s_0,s_1,\dots,s_{i-1})$, where we set $s_0=0$. (In general, though, stages should be indexed by a parameter different from the player index. But in your game, since each player moves exactly once, we can use the same index for stages as well as players to economize notation.) The history dependent strategy space for player $i$ would thus be
\begin{equation}
S_i(h^i)=
\begin{cases}
\{1,\dots,n-\sum_{j=0}^{i-1}s_j\} & \text{if } n-\sum_{j=0}^{i-1}s_j\ge 1 \\
\{0\} & \text{otherwise}.
\end{cases}
\end{equation}

I was carefully rereading the underlying paper (Bloch, 1996) and found what I was looking for. Let $N = \{1,\ldots,n\}$ denote the set of agents and let $\Pi_{\{1, \ldots, i-1\}}$ denote the set of coalition structures of $\{1, \ldots, i-1\}$ for all $i \in \{2,\ldots,n\}$. A strategy in the game of coalition size is a mapping $s_i : \Pi_{\{1, \ldots, i-1\}} \to \{1, \ldots, n-(i-1)\}$ for all $i \in \{2,\ldots,n\}$. Further $s_1 \in N$.

Example with $n=4$. With some abuse of notation (saving curly brackets) we get
\begin{align}
&s_1 \in \{1,2,3,4\}\\
&s_2:\{1\} \to \{1,2,3\}\\
&s_3:\{\{1,2\},\{12\}\} \to \{1,2\}\\
&s_4:\{\{1,2,3\},\{12,3\},\{1,23\},\{123\}\} \to \{1\}
\end{align}

  Bloch (1996): "Sequential Formation of Coalitions in Games with Externalities and Fixed Payoff Division", GEB


The Backward Bending Supply Curve, Asymmetric Information, and Monopoly This recent question about when monopoly is undesirable made me curious about when monopoly is actually desirable? I was reminded of an argument for the efficiency of monopolies when moral hazard effects create a backward-bending supply curve in competition, like in healthcare perhaps. But, for the life of me, I cannot remember exactly how this was justified or if I am just imagining the whole thing. Is anyone familiar with arguments like this?

I know you can create a backward bending marginal cost curve and then with the usual linear marginal revenue curve, you might have MR=MC at a greater quantity than where demand intersects marginal cost, but I don't understand how the backward bending supply is also a a marginal cost curve--then the curve isn't even a proper function.

Information is a funny thing, so I wouldn't be surprised if incomplete information made for strange results.

Edit: I am thinking of pictures like these. I am just having a hard time reconstructing the jump from a backwards bending supply or demand curve (I understand these--this is often taught in 101), I just don't understand the MB/MC interpretation below where it seems like you might get a higher equilibrium quantity with monopsony or monopoly.

For these to make sense, MC and MB can't be functions of quantity unless I have a marginal cost in each direction? As in I could sell $q_1$ at a high price a low price, so am I approaching from above or below.

This definitely is not a complete answer. But I can imagine the case of increasing returns to scale. Or natural entry barrier. Increasing returns to scale is often discussed in international trade theory, but it can be also relevant here.

Example: think about commercial aircraft industry, dominated by Boeing and Airbus. Aircraft industry is seen as exhibiting increasing returns to scale, so monopolistic power those companies have (well, it is oligopoly, but that does not change the conclusion) may actually lead to cheaper quality aircraft.

Now there are people who really believe that all monopolistic powers are undesirable, but I believe those people are only minorities.

A "backward bending" supply curve is evidence of a a supplier "monopoly." An example of such is a labor union, that has a "monopoly" on labor in a region, meaning that no one else can produce widgets for the monopolist; just as the widget producer is a monopolist because it has no competitors.

Normally, monopolies are frowned upon, because they have "too much" power, relative to other agents. On the other hand, if you have a "monopoly" that can move anywhere along the demand curve at will, and a labor "monopoly" that can confront the whole supply curve, maybe you have two operators with "countervailing" power that balance each other out.


Why don't Burgers cost 5 cents? In this blog post, economist Bob Murphy raises a puzzle involving the principle that in a competitive market, the price equals the marginal cost:

  There’s a general principle from intro to microeconomics that says in
  a competitive industry, in equilibrium P=MC. So how would we actually
  apply that in practice to the fast food industry? At the point at
  which the burgers are already made and sitting on the back warmer,
  what’s the marginal cost to the firm of the worker picking up the
  burger and handing it to a customer? 5 cents? So, in an efficient fast
  food industry, burgers should be priced at 5 cents. Don’t you dare say
  that the firm needs to charge at least enough to cover average costs,
  because (as David points out) that involves a sunk cost fallacy…
  Something is obviously not right in the above. But I’m curious to see
  how you guys would unpack it. If you want to say, “I don’t trust them
  there textbooks with their funny graphs!” OK fine, but ideally I’d
  like you to solve it within the world of standard textbook micro,
  since presumably that can be done.

What he's saying is that once the burger is already made, the cost of making the burger is a sunk cost, and thus the marginal cost of the burger is just the cost of the tiny labor involved in picking it up and selling it to the customer.

So why is it that in the fast food industry, the price of a burger takes into account the cost of making the burger and not just the cost of handing it over to the customer?  Is it because the fast food industry is far away from the conditions of perfect competition, or can this be explained using a perfect competition model?

What he's saying is that once the burger is already made, the cost of making the burger is a sunk cost, and thus the marginal cost of the burger is just the cost of the tiny labor involved in picking it up and selling it to the customer.

That's sort of an odd position to take.

Obviously once the burger is cooked you can't recuperate the costs, but in the aggregate, the decision to cook some number of burgers in such and such a time period is made before actually cooking them. So the cost of making a burger (including labor) isn't a sunk cost; it's a prospective cost.

Additionally, just because the monetary cost of making the burger is the same for each burger doesn't make it a sunk cost, just fixed (perhaps). But more to the point, there's a time cost which varies the more burgers you cook. We pay for convenience. Part of the marginal cost of cooking the burger is the opportunity cost of that time that could be spent not running a nice little fast food restaurant.

Because it`s like Coca-cola, when MC is super low or almost nothing, but you are paying a lot for the brand, which gives you emotional satisfaction. Even if you were only aware of the choice of Cola rather than say Pepsi only an unconscious level. They make you want it, and you should pay for it.