question
explicit costs
answer
cost that requires an outlay of money
question
implicit costs
answer
measured by the value, in dollar terms, of the benefits that are forgone; does not require an outlay of money
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accounting profit
answer
revenue - explicit costs
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economic profit
answer
revenue - explicit costs - implicit costs
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capital
answer
total value of the assets of an individual or a firm
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implicit cost of capital
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the income the owner of the capital could have earned if the capital had been employed in its next best alternative use;
the opportunity cost of using self-owned capital
the opportunity cost of using self-owned capital
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either-or decisions
answer
decision is one in which you must choose between two activities;
choose the activity with the positive economic profit
choose the activity with the positive economic profit
question
how much decisions
answer
requires you to choose how much of a given activity to undertake
question
marginal benefit
answer
the benefit of doing a little bit more of something;
calculated from total benefit
calculated from total benefit
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marginal cost
answer
the additional cost incurred by producing one more unit of that good or service;
calculated from total cost;
marginal cost is equal to slope of total cost curve
calculated from total cost;
marginal cost is equal to slope of total cost curve
question
increasing marginal cost
answer
occurs when each unit of a good costs more to produce than the previous unit
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constant marginal cost
answer
occurs when the cost of producing an additional unit is the same as the cost of producing the previous unit
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decreasing marginal cost
answer
occurs when marginal cost falls as the number of units produced increases
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decreasing marginal benefit
answer
each additional year of school yields a smaller benefit than the previous year
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optimal quantity
answer
the quantity that generates the maximum possible total profit;
graphically located where MB and MC intersect;
for small quantities: increase the quantity as long as the marginal benefit from one more unit is greater than the marginal cost, but stop before the marginal benefit becomes less than the marginal cost
for large, how much decisions: the optimal quantity is the quantity at which marginal benefit is equal to marginal cost
graphically located where MB and MC intersect;
for small quantities: increase the quantity as long as the marginal benefit from one more unit is greater than the marginal cost, but stop before the marginal benefit becomes less than the marginal cost
for large, how much decisions: the optimal quantity is the quantity at which marginal benefit is equal to marginal cost
question
profit-maximizing principle of marginal analysis
answer
the optimal quantity is the largest quantity at which marginal benefit is greater than or equal to marginal cost
question
sunk costs
answer
costs that have already been incurred and cannot be recovered; sunk costs are not opportunity costs, so they shouldn't be considered
question
behavioral economics
answer
branch of economics that combines economic modeling with insights from human psychology in order to understand how people actually — instead of theoretically — make economic choices
question
4 reasons people don't act rationally
answer
1. concerns over fairness
2. non monetary rewards
3. bounded rationality
4. risk aversion
2. non monetary rewards
3. bounded rationality
4. risk aversion
question
7 common mistakes in decision making
answer
1. misperceptions of opportunity cost
2. overconfidence
3. unrealistic expectations of future behavior
4. counting dollars unequally
5. loss aversion
6. framing bias
7. status quo basis
2. overconfidence
3. unrealistic expectations of future behavior
4. counting dollars unequally
5. loss aversion
6. framing bias
7. status quo basis
question
utility
answer
some personal measure of the satisfaction gained from consumption of goods and services
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consumption bundle
answer
the set of all the goods and services an individual consumes
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utility function
answer
the relationship between an individual's consumption bundle and the total amount of utility it generates for that individual
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marginal utility
answer
the change in total utility from consuming one additional good or service;
often subject to diminishing marginal utility
often subject to diminishing marginal utility
question
principle of diminishing marginal utility
answer
the additional satisfaction a consumer gets from one more unit of a good or service declines as the amount of that good or service consumed rises
question
budget line
answer
hows all the consumption bundles available to Sammy when he spends all of his income
question
optimal consumption bundle
answer
the consumption bundle that maximizes his total utility given the budget constraint;
-MU1/MU2 = -P1/P2
-MU1/MU2 = -P1/P2
question
marginal utility per dollar
answer
the additional utility from spending one more dollar on that good or service;
whenever marginal utility per dollar is higher for one good than for another good, the consumer should spend $1 more on the good with the higher marginal utility per dollar and $1 less on the other
marginal utility/price of good;
whenever marginal utility per dollar is higher for one good than for another good, the consumer should spend $1 more on the good with the higher marginal utility per dollar and $1 less on the other
marginal utility/price of good;
question
utility-maximizing principle of marginal analysis
answer
the marginal utility per dollar spent on each good or service in the consumption bundle is the same
question
substitution effect
answer
the change in the quantity consumed as the consumer substitutes other goods that are now relatively cheaper in place of the good that has become relatively more expensive;
when consumers react to an increase in a good's price by consuming less of that good and more of other goods
when consumers react to an increase in a good's price by consuming less of that good and more of other goods
question
income effect
answer
change in the quantity of a good consumed that results from a change in the overall purchasing power of the consumer due to a change in the price of that good;
the change in consumption resulting from a change in real income
the change in consumption resulting from a change in real income
question
Giffen good
answer
a good that has an upward-sloping demand curve;
a type of inferior good for which the income effect is so strong that it dominates the substitution effect
a type of inferior good for which the income effect is so strong that it dominates the substitution effect
question
indifference curve
answer
graph that maps consumption bundles yielding the same amount of total utility
question
properties of indifference curves
answer
1. the curves never cross
2. the farther out an indifference curve lies, the higher the level of total utility it indicates
3. curves slope downward
4. curves have a convex shape
2. the farther out an indifference curve lies, the higher the level of total utility it indicates
3. curves slope downward
4. curves have a convex shape
question
slope of indifference curve = -marginal rate of substitution
answer
-MU1/MU2
question
change in total utility
answer
MU x (delta)Q
question
marginal rate of substitution equation
answer
deltaQ(m)/deltaQ(r) = -MU(r)/MU(m)
^ indicates slope of indifference curve
negative the ratio of marginal utility ^
^ indicates slope of indifference curve
negative the ratio of marginal utility ^
question
diminishing marginal rate of substitution
answer
an individual who consumes only a little bit of good A and a lot of good B will be willing to trade a lot of B in return for one more unit of A
question
ordinary goods
answer
possess two properties:
1. the consumer requires more of one good to compensate for less of the other
2. the consumer experiences a diminishing marginal rate of substitution when substituting one good in place of the other
1. the consumer requires more of one good to compensate for less of the other
2. the consumer experiences a diminishing marginal rate of substitution when substituting one good in place of the other
question
relative price
answer
illustrates the opportunity cost to an individual of consuming one more unit of one good in terms of how much of the other good in his or her consumption bundle must be forgone;
P1/P2
P1/P2
question
perfect substitutes
answer
indifference curves are straight lines; marginal rate of substitution is constant
question
perfect complements
answer
indifference curves form right angles; marginal rate of substitution is undefined
when a consumer wants to consume two goods in the same ratio, regardless of their relative price
when a consumer wants to consume two goods in the same ratio, regardless of their relative price
question
production function
answer
the quantity of output a firm produces depends on the quantity of inputs
question
long run
answer
given that a long enough period of time has elapsed — firms can adjust the quantity of any input;
there are no fixed costs
there are no fixed costs
question
short run
answer
the time period during which at least one input is fixed
question
total product curve
answer
a graphical representation of the production function, showing how the quantity of output depends on the quantity of the variable input for a given quantity of the fixed input
question
marginal product
answer
the additional quantity of output that is produced by using one more unit of that input;
marginal product is equal to slope of total product curve
marginal product is equal to slope of total product curve
question
total cost is equal to
answer
TC = FC + VC
question
total product and total cost curve relationship
answer
as output increases, the marginal cost of output also increases because the marginal product of the variable input decreases
question
spreading effect
answer
The larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost
question
diminishing returns effect
answer
The larger the output, the greater the amount of variable input required to produce additional units, leading to higher average variable cost
question
minimum average total cost
answer
MC = ATC
question
MC and ATC curve relationship
answer
1. At the minimum-cost output, average total cost is equal to marginal cost.
2. At output less than the minimum-cost output, marginal cost is less than average total cost and average total cost is falling.
3. At output greater than the minimum-cost output, marginal cost is greater than average total cost and average total cost is rising.
2. At output less than the minimum-cost output, marginal cost is less than average total cost and average total cost is falling.
3. At output greater than the minimum-cost output, marginal cost is greater than average total cost and average total cost is rising.
question
increasing returns to scale (economies of scale)
answer
when LRATC declines as output increases;
causes: increased specialization, very large initial set ups (ie. auto manufacturing, electricity power plants, petroleum refining), network externalities
causes: increased specialization, very large initial set ups (ie. auto manufacturing, electricity power plants, petroleum refining), network externalities
question
decreasing returns to scale (diseconomies of scale)
answer
when LRATC increases as output increases
causes: problems of coordination and communication,
causes: problems of coordination and communication,
question
constant returns to scale
answer
when LRATC is constant as output increases
question
price-taking producer
answer
A producer is a price-taker when its actions cannot affect the market price of the good or service it sells;
during perfect competition, every producer is a price-taker
during perfect competition, every producer is a price-taker
question
price-taking consumer
answer
a consumer who cannot influence the market price of the good or service by their actions
question
perfectly competitive market
answer
all market participants, both consumers and producers, are price-takers; no one effects market price
question
conditions for perfect competition
answer
1. it must contain many producers, none of whom have a large market share
2. consumers regard the products of all producers as equivalent (substitutes); the industry output is a standardized product
3. it is easy for new firms to enter the industry or for firms that are currently in the industry to leave (this condition is not necessary though)
2. consumers regard the products of all producers as equivalent (substitutes); the industry output is a standardized product
3. it is easy for new firms to enter the industry or for firms that are currently in the industry to leave (this condition is not necessary though)
question
standardized product
answer
a product that consumers regard as the same good even when it comes from different producers
question
optimal output rule
answer
MR (MB)=MC;
note: during perfect competition, firms are price-takers so they have to sell at market price, so MR is a horizontal line
note: during perfect competition, firms are price-takers so they have to sell at market price, so MR is a horizontal line
question
price-taking firm's optimal output rule
answer
a price-taking firm's profit is maximized by producing the quantity of output up to the point at which the market price is equal to the marginal cost of the last unit produced; P = MC (and MR = P)
question
profitable?
answer
P>ATC - profitable
P=ATC - break even
P<ATC - incur of a loss
P=ATC - break even
P<ATC - incur of a loss
question
what to do when MR is
answer
above MC --> produce in the short run
equal to the shut down price (minimum AVC) --> indifferent, but assumes to keep producing
between shut down and break even price --> better off producing in the short run
equal to the shut down price (minimum AVC) --> indifferent, but assumes to keep producing
between shut down and break even price --> better off producing in the short run
question
in the long run...
answer
1. if price consistently falls below minimum average total cost, a firm will exit the industry
2. if price exceeds minimum average total cost, the firm is profitable and will remain in the industry; other firms will enter the industry in the long run.
2. if price exceeds minimum average total cost, the firm is profitable and will remain in the industry; other firms will enter the industry in the long run.
question
industry supply curve
answer
the relationship between the price and the total output of an industry as a whole
question
short run industry supply curve
answer
shows the quantity that producers will supply at each price, taking the number of producers as given
question
short run market equilibrium
answer
the quantity supplied equals the quantity demanded, taking the number of producers as given
question
long run market equilibrium
answer
a situation in which the quantity supplied equals the quantity demanded given that sufficient time has elapsed for producers to either enter or exit the industry
question
long-run industry supply curve
answer
shows how the quantity supplied by an industry responds to the price given that producers have had time to enter or exit the industry;
in perfectly elastic conditions, the long run is constant (horizontal line)
in perfectly elastic conditions, the long run is constant (horizontal line)
question
3 conclusions about the cost of production and efficiency in the long-run equilibrium of a perfectly competitive industry
answer
1. In a perfectly competitive industry in equilibrium, the value of marginal cost is the same for all firms
2. In a perfectly competitive industry with free entry and exit, each firm will have zero economic profit in long-run equilibrium
3. The long-run market equilibrium of a perfectly competitive industry is efficient: no mutually beneficial transactions go unexploited
2. In a perfectly competitive industry with free entry and exit, each firm will have zero economic profit in long-run equilibrium
3. The long-run market equilibrium of a perfectly competitive industry is efficient: no mutually beneficial transactions go unexploited
question
utility maximization
answer
MU/P;
consume the good at which marginal utility per price is higher
consume the good at which marginal utility per price is higher
question
market power
answer
the ability of a monopolist to raise the price of its product above the competitive level by reducing output
question
barriers to entry (monopoly)
answer
1. control of a scarce resource or input
2. increasing returns to scale (ie. local utilities)
3. technological superiority
4. network externalities: the value of a good or service to an individual is greater if many others use the same good or service
5. government created barrier to entry
2. increasing returns to scale (ie. local utilities)
3. technological superiority
4. network externalities: the value of a good or service to an individual is greater if many others use the same good or service
5. government created barrier to entry
question
natural monopoly
answer
A monopoly created and sustained by increasing returns to scale;
downward sloping average total cost curve
downward sloping average total cost curve
question
2 opposing effects on revenue
answer
1. quantity effect: one more unit is sold, increasing total revenue by the price at which the unit is sold
2. price effect: to sell the last unit, the monopolist must cut the market price on all units sold
2. price effect: to sell the last unit, the monopolist must cut the market price on all units sold
question
TR curve of monopolists
answer
- at low levels of output, the quantity effect is stronger than the price effect (positive slope) (price effect is small)
- at high levels of output, the price effect is stronger than the quantity effect (negative slope) (price effect is large)
- at high levels of output, the price effect is stronger than the quantity effect (negative slope) (price effect is large)
question
monopsonist
answer
a single buyer in a market;
can affect the price of the good it buys: it captures surplus from sellers by reducing how much it purchases and thereby lowers the price paid to the seller
can affect the price of the good it buys: it captures surplus from sellers by reducing how much it purchases and thereby lowers the price paid to the seller
question
single price monopolist
answer
one that charges all consumers the same price
question
perfect price discrimination
answer
When a monopolist is able to capture the entire surplus;
In general, the greater the number of different prices a monopolist is able to charge, the closer it can get to perfect price discrimination (causes there to be a consumer surplus and no inefficiency)
In general, the greater the number of different prices a monopolist is able to charge, the closer it can get to perfect price discrimination (causes there to be a consumer surplus and no inefficiency)
question
monopolists charging different prices
answer
1. The greater the number of prices the monopolist charges, the lower the lowest price — that is, some consumers will pay prices that approach marginal cost.
2. The greater the number of prices the monopolist charges, the more money it extracts from consumers.
2. The greater the number of prices the monopolist charges, the more money it extracts from consumers.
question
imperfect competition
answer
a situation in which firms compete but also possess market power — which enables them to affect market prices
question
Herfindahl-Hirschman Index (HHI)
answer
calculated as the square of each firm's market share summed over the firms in the industry;
HHI below 1500 - unconcentrated industry
1500-2500 - moderately concentrated
over 2500 - concentrated industry
HHI below 1500 - unconcentrated industry
1500-2500 - moderately concentrated
over 2500 - concentrated industry
question
interdependence
answer
the pricing and production decisions of one firm significantly affect the profits of its rivals
question
collusion
answer
when companies cooperate to raise their joint profits;
question
cartel
answer
the strongest form of collusion;
an arrangement between producers that determines how much each is allowed to produce
an arrangement between producers that determines how much each is allowed to produce
question
non-cooperative behavior
answer
each firm acting in its own self-interest, even though this has the effect of driving down everyone's profits
question
game theory
answer
deals with any situation in which the reward to any one player depends not only on their own actions but also on those of other players in the game
question
prisoner's dilemma
answer
When each firm has an incentive to cheat, but both are worse off if both cheat, the situation
question
dominant strategy
answer
when it is the player's best action regardless of the action taken by the other player
question
Nash equilibrium (noncooperative equilibrium)
answer
In game theory, this kind of equilibrium, in which each player takes the action that is best for him or her given the actions taken by other players;
question
strategic behavior
answer
taking account of the effects of the action it chooses today on the future actions of other players in the game
question
tit for tat
answer
form of strategic behavior intended to influence the future actions of other players;
offers a reward to the other player for cooperative behavior
offers a reward to the other player for cooperative behavior
question
tacit collusion
answer
cooperation among producers, without a formal agreement, to limit production and raise prices so as to raise one another's profit;
the normal state of oligopoly
the normal state of oligopoly
question
antitrust policy
answer
government regulation aimed at preventing monopoly and fostering competition in markets where competition is desirable
question
factors making it difficult to coordinate on high prices
answer
1. less concentration - more firms in oligopoly = less incentive for firms to cooperate
2. complex products and pricing schemes - oligopolists produce many products, making it difficult to track competitor actions
3. differences in interests - firms differ in perceived fairness and strategies in their interests
4. bargaining power of buyers - oligopolists sell to larger buyers who can bargain for lower prices
2. complex products and pricing schemes - oligopolists produce many products, making it difficult to track competitor actions
3. differences in interests - firms differ in perceived fairness and strategies in their interests
4. bargaining power of buyers - oligopolists sell to larger buyers who can bargain for lower prices
question
price war
answer
involves simply a collapse of prices to their noncooperative level. Sometimes they even go below that level, as sellers try to put each other out of business or at least punish what they regard as cheating;
result after the collapse of a collusion
result after the collapse of a collusion
question
product differentiation
answer
firms make considerable efforts to create the perception that their product is different;
firms get more market power when buyers think their product is different
firms get more market power when buyers think their product is different
question
price leadership
answer
one company tacitly sets prices for the industry as a whole
question
non price competition
answer
adding new features to their products, spending large sums on ads that proclaim the inferiority of their rivals' offerings, and so on
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