SOLUTION: Monetarist Theory Discussion – Studypool

SOLUTION: Monetarist Theory Discussion – Studypool.

Printing money is valid response to coronavirus crisis | Financial Times
Opinion The FT View
Printing money is valid response to coronavirus crisis
Quantitative easing programmes may be here for the long term
The scale of today’s downturn means even the most direct monetary financing, such as ‘helicopter money’, should remain an option © Dado
The editorial board YESTERDAY
The British government has never paid off the £1,200,000 loan that created the Bank
of England in 1694. In exchange it gave the merchants who provided the money the
exclusive right to print banknotes against this debt, giving birth to the central bank
and much of the architecture behind the world’s financial system. Today, as
policymakers promise to do “whatever it takes” to prop up their economies in the face
of coronavirus, central banks are facing calls to print money to finance government
spending directly.
In times of emergency, particularly war, central banks have often handed freshly
printed banknotes to governments. The fight against resultant inflation was
postponed until after any crisis. Despite the pandemic, the world is not yet in that
position today. There is no need, for now, to relax the framework of independent,
inflation-targeting central banking. Yet this kind of monetary financing should be a
tool available to policymakers, if needed.
Printing money is valid response to coronavirus crisis | Financial Times
Without limits, allowing a government to finance itself by creating money can lead to
hyperinflation. But these risks can be manageable: the quantitative easing of the past
decade, despite predictions, has not lifted inflation above the main central banks’ 2
per cent targets. The money pumped into rich-world economies has been met by
increased demand, perhaps permanently, for precautionary saving.
There is no clear distinction between quantitative easing and monetary financing.
Central bankers say asset purchases under QE are temporary, meaning the newlycreated money will one day be removed from the economy. But it is hard to bind the
hands of their successors, who could one day make them permanent. Either way, the
effect is to lower the cost of government borrowing. Buying the bonds only after they
have been sold to private investors still frees up funds for new issues.
Recent QE programmes, in fact, look increasingly likely to become permanent.
Central bankers were unable to complete a much-discussed programme of
“normalising” monetary policy between the financial crisis and today’s crash. They are
not going to be able to do so any time soon. The scale of previous schemes means the
Bank of Japan — which holds government bonds worth more than 100 per cent of
Japanese national income — may never be able fully to unwind its purchases.
The difference between QE and direct monetary financing is mostly one of
presentation: whether asset purchases are deemed temporary or permanent. This
matters: credibility and messaging are important features of central banking. An
opinion article this week by Andrew Bailey, the Bank of England governor, that ruled
out monetary financing may have been largely conceived to convince international
investors that there is little reason to fear keeping funds in sterling.
Editor’s note
If trends restraining inflation go into reverse,
central bankers have tools to combat rising
prices, whether through raising interest rates
or unwinding QE. The present crisis may even
be deflationary and central banks’ targets are,
with the exception of the European Central
Bank, symmetric in promising to tackle
Printing money is valid response to coronavirus crisis | Financial Times
inflation that is both below and above their
stated goal.
The Financial Times is making key
coronavirus coverage free to read to
help everyone stay informed.
The scale of today’s downturn means even the
Find the latest here.
“helicopter money”, or handing cash to the
most direct monetary financing, such as
public, should remain an option. This will
require co-ordination with democratically
elected officials, who are responsible for the public finances. The debate should not be
over whether monetary financing can happen — in QE, it already is — but over
keeping the process under control via independent central banks.
Copyright The Financial Times Limited 2020. All rights reserved.
Market Structures
• Do laws of demand and supply and equilibrium behave the same in
every market?
• Each market has different results in terms of commodities,
technology, information, taxes, regulation, participants, etc, that
make it unique
• However, there are common features that allow us to classify markets
into certain structures
• Market structures: models that capture how markets are organized
Classical market structures
1. Perfect competitive market:
Market power: the ability to affect prices
2. Monopoly: one seller, many buyers
3. Monopsony: one buyer, many sellers
4. Oligopoly: small number of large sellers
Perfect competition
• Theoretical construction

Large number of buyers and sellers
Firms and consumers are price takers
Product homogeneity: goods are perfect substitutes
Information is available for everyone
Free entry and exit: less efficient companies will leave
• Sellers decide the quantity that they produce in order to maximize

Sector is one firm – one producer
Supply from the firm is the supply for the whole sector
Demand for the firm is the demand for the whole sector
Firm produces a commodity that there is no perfect substitute for
What contributes to monopolies?

Size of the market
Government laws and protection
Control over sources of raw materials
• Monopolies may have extraordinary profit
• Normal profit: includes income for businessman, and its opportunity cost
• Extraordinary profit: profit beyond normal
• Usually, a monopoly is maintained through government protection or high costs of
• Airlines, transportation companies, pharma, chemical sector, etc
• Reduced number of producers and sellers
• Goods are not perfect substitutes
• Decision by one seller influences others (game theory)
• Many sellers and one buyer
• Labor market
• Example: one large company in a small town
Antitrust laws
• Since having market power means gaining profits at the expense of consumers (with the
ability of affecting prices), most countries have antitrust laws – designed to prevent large
M&As and promote a competitive economy.
• Monopolies are not illegal. In fact, property laws, copyright laws, patents, protect
monopolies. What is illegal is using the monopoly power to prevent other companies from
entering the market.
• Antitrust laws prevent:
• Parallel conduct: Form of implicit collusion in which one firm consistently follows actions of another.
• Predatory pricing: pricing designed to drive current competitors out of business and to discourage new
entrants (dumping, for example)
• Collusion, cartel
• M&A that “substantially lessen competition” or “tend to create a monopoly.”
Game Theory
Although firms cannot collude on prices, that does
not mean that they do not take other firms into
consideration – GAME THEORY
• Firms in an oligopoly should be concerned about possible strategies from
• Will it be more aggressive? Moderate? Should it just wait?
• Ex. A company producing laundry detergent deciding whether to launch a new
• It will have to invest in R&D, marketing campaign, etc
• Revenues depend on launching and getting market share
• How will competitors react? Is it worth investing?
• Game Theory: decisions by one agent affects others and vice-versa
• It analyses how decisions are made
• We assume all actions are taken with a goal in mind and maximizing this goal
• So far, we have analyzed decisions by consumers and firms where the result depended
only on individual actions. Now we will analyze an environment where STRATEGY
Prisoner’s dilemma
• Most common example of game theory
• “game” in which 2 individuals must make a decision and its result
depends on the interaction of the 2 decisions
• 2 people are jailed suspected of having committed a crime together
• Police put the 2 in separate cells, so communication between them is
not possible
• Police ask each one if they have committed the crime or not and
propose the following:
A) if prisoner 1 does not confess and prisoner 2 confesses (reporting that
both committed the crime), the one that did not confess (1) will get 10
years, while #2 will get no penalty
B) if both confess, they will get 5 years each
C) if no one confesses, they will both get one year
• What should they do? What is the best strategy?
• If one confesses, possible results:
• Go to jail for 5 years if the other also confesses
• Go free, if the other does not confess
• If one does not confess, possible results:
• Go to jail for 1 year, if the other also does not confess
• Go to jail for 10 years, if the other one confesses
• The best result would be for both not to confess and go to jail for one year
• But they cannot communicate!
• If one confesses, one will go free – so, knowing that the other one can betray,
both have strong incentives to confess, seeking to get 5 years instead of 10 or
even go free
• Result ends up being both confess – not the best solution for both
• This is a non-cooperative game
What is a “game”?
• A model, abstraction of reality
• Set of rules and their results
• Rules describe the “reality”, narrowing down possible actions by
agents (players)
• Players are making rational and maximizing decisions, based on
possible results
• Possible results: payoffs
• outcomes that generate rewards or benefits
• For firms, payoffs are profits
• Agents that are making decisions – consumers, firms, investors, banks,
• How many players in a game?
• In models, most games have 2 players
• What is the optimal strategy for each player? A strategy is a rule or plan of
action for playing the game. The optimal strategy for a player is the one
that maximizes the expected payoff.
• Games can be cooperative or noncooperative. In a cooperative game,
players can negotiate and plan joint strategies. In a noncooperative game,
negotiation and cooperation are not possible.
Cooperative vs. noncooperative games
• A cooperative game would involve two firms negotiating a joint
investment to develop a new technology, for example.
• An example of a noncooperative game is a situation in which two
competing firms take each other’s likely behavior into account when
independently setting their prices. Each firm knows that by
undercutting its competitor, it can capture more market share. But it
also knows that in doing so, it risks setting off a price war.
• We will be concerned mostly with noncooperative games.
• What does a player know?
• What does a player know regarding preferences from other players
and payoffs?
Games with perfect information: decisions are done in sequence – one player
makes the decision after the other player (chess game)
Games with imperfect information: players are making decisions at the same
time (rock, paper, scissor)
How to formalize a game – Decision tree
Enter the
company B
Company A
Price war with
company A
Payoff 1
No price war
with company A
Payoff 2
Do not enter
the market
Game with 2 players, in sequence, non cooperative, with perfect information
Payoffs may be profits from company A and company B
If price war starts, profits will decrease
Payoff 3
How to formalize a game – Payoff matrix
• More common for simultaneous games
• Prisoner’s dilemma:
Prisoner 2
Prisoner 1
Does not confess
Does not confess
• What is the best way to play the game?
• Dominant strategy
• Nash
• The best strategy is always the one that guarantees the best payoff
given the other player’s strategy.
Noncooperative games
• It is essential to understand your opponent’s point of view and to deduce
his or her likely responses to your actions.
• Some strategies may be successful if competitors make certain choices but
fail if they make other choices. Other strategies, however, may be
successful regardless of what competitors do. We begin with the concept
of a dominant strategy—one that is optimal no matter what an opponent
• Suppose Firms A and B sell competing products and are deciding whether
to undertake advertising campaigns. Each firm will be affected by its
competitor’s decision.
• Let’s first consider firm A. What should it do?
• It should advertise, no matter what firm B does. Thus advertising is a
dominant strategy for Firm A
• The same is true for firm B.
• Therefore, assuming that both firms are rational, we know that the
outcome for this game is that both firms will advertise. This outcome is
easy to determine because both firms have dominant strategies.
• When every player has a dominant strategy, we call the outcome of the
game an equilibrium in dominant strategies.
What is the dominant strategy in this game?
For the monopolistic firm, it is best not to start a price war, since its profit will be 80, instead of 70.
Company A knows that, and its dominant strategy is to enter to market.
However, not all games are like this. Let’s change
our payoff matrix a little bit:
• Now, if neither firm advertises, Firm B will again earn a profit of 2, but Firm A will
earn a profit of 20.
• Now Firm A has no dominant strategy, it depends on what firm B does.
• If Firm B advertises, Firm A does best by advertising; but if Firm B does not
advertise, Firm A also does best by not advertising.
• Now suppose both firms must make their decisions at the same time. What
should Firm A do?
• To answer this, Firm A must put itself in Firm B’s shoes. What decision is best
from Firm B’s point of view, and what is Firm B likely to do? The answer is clear:
Firm B has a dominant strategy—advertise, no matter what Firm A does.
• Therefore, Firm A can conclude that Firm B will advertise. This means that Firm A
should advertise.
• Nash equilibrium is a set of strategies (or actions) such that each player is doing
the best it can given the actions of its opponents. It is a ‘no-regret’ strategy – the
player could not have improved its situation modifying its strategy (different than
the prisoner’s dilemma)

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SOLUTION: Monetarist Theory Discussion – Studypool

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