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industrial organization
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the study of how firms' decisions regarding prices and quantities depend on the market conditions they face.
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total revenue (for a firm)
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the amount paid by buyers and recieved by sellers of a good. = TR = P*Q
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Total cost
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the market value of the inputs a firm uses in production.
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Profit
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total revenue minus total cost ( P = TR-TC)
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explicit costs
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input costs that require an outlay of money by the firm
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implicit costs
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input costs that do not require an outlay of money by the firm. (money does not flow outside of the firm)
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production function
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shows the relationship between the number of workers hired and the qty of output produced. Gets flatter as the units increase on the X-axis (horizontal)
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total cost curve
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shows the relationship between the qty of output produced and the total cost of production. Gets steeper as the qty of output increases - y-axis (vertical)
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marginal product
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the increase in output (x-axis) that arises from an additional unit of input.
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diminishing marginal product
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the property whereby the marginal product of an input declines (y-axis) as the qty of the input increases.
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fixed costs
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costs that do not vary with the quantity of output produced. they are incurred even if the firm produces nothing at all (rent)
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variable cost
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costs that vary with the qty of output produced.
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total cost
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the sum of the firms fixed and variable costs (tc = f + v)
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average total cost
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divide the firms total cost by the qty of output. ( ATC= TC / QTY) = ATC line on the graph is curved in a U-shape
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average fixed cost
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fixed costs divided by the quantity of output
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average variable cost
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variable costs divided by the quantity of output
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marginal cost
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the increase in total cost that arises from an extra unit of production. (MC = delta tc / delta qty). / mc line on the graph rises with qty of input and crosses the ATC curve @ the min of atc
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efficient scale
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the quantity of output that minimizes average total cost.
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the relationship between MC and ATC
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whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising.
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most important properties that cost curves share
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1) Marginal cost eventually rises with the qty of output.
2) the ATC curve is U shaped
3) the MC curve crosses the ATC curve at the min. point.
2) the ATC curve is U shaped
3) the MC curve crosses the ATC curve at the min. point.
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ATC in the short and long runs
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because fixed costs are variable in the long run, the ATC curve in the short run differs from the curve in the long run.
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economies of scale
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the property whereby long-run ATC falls as the qty of output increases
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diseconomies of scale
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the property whereby long run ATC costs rises as the qty of out increases
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constant returns to scale
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the property whereby long run ATC stays the same as the qty of output changes
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cause of economies of scale
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specialization among workers, permitting each worker to become better at a specific task
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cause of diseconomies of scale
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coordination problems, more stretched a team becomes the less effective they become.
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economic profit
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total revenue minus total cost (including implicit and explicit costs)
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accounting profit
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total revenue minus total explicit costs
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What distinguishes short-run cost analysis from long-run?
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In the short-run, the size of the factory is fixed.
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What is the relationship between economic profit and accounting profit?
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Economic profit will never exceed accounting profit.
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What happens when marginal product is falling?
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Marginal cost rises.
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short-run production function
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The production function depicts the relationship between the qty of labour and the qty of output.
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Marginal Revenue (MR)
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The additional income from selling one more good of a unit; MR=P in a competitive firm. MR = TR/change in QTY
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shutdown
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a short-run decision not to produce anything because of market conditions
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price taker
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must accept the price
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exit
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a long-run decision to leave the market
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characteristics of a perfectly competitive market
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1. There are many buyers and sellers
2. the goods offered are largely the same
3. Firms can freely enter and exit the market
2. the goods offered are largely the same
3. Firms can freely enter and exit the market
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start-up price
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price that exceeds the shut-down price - the firm can reopen.
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Average Revenue
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total revenue / by qty sold for all firms. AVR = P
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Shutdown price
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is the min. point on the AVC cost curve
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3 general rules for profit maximization
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1. If marginal revenue is greater than marginal cost, the firm should increase its output
2. If marginal cost is greater than marginal revenue, the firm should decrease its output
3. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal
2. If marginal cost is greater than marginal revenue, the firm should decrease its output
3. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal
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reasons why the long-run market supply curve will slope upward
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1. resources used are limited (land used by farmers)
2. firms may have different costs
2. firms may have different costs
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market power
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when a firm can influence the market price of the goods it sells.
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Competitive market
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a market in which there are many buyers and many sellers so that each has a negligible impact on the market price
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sunk cost
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a cost that has already been committed and cannot be recovered.
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Monopoly
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a firm that is the sole seller of a product without close substitutes.
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Three main sources of "Barriers to Entry"
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1. Monopoly resources: a key resource is owned by a single firm.
2. Government Regulation: The government gives a single firm the exclusive right to produce some good or service.
3. The production process: A single firm can produce output at a lower cost than can a large number of producers
2. Government Regulation: The government gives a single firm the exclusive right to produce some good or service.
3. The production process: A single firm can produce output at a lower cost than can a large number of producers
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Natural Monopoly
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a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
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Competitive Market Demand Curve Slope
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Is horizontal - Firms can sell as much or as little at the market set price.
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Monopoly Market Demand Curve
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The same as the market demand - slope is downwards. If price goes up, demand will drop. If qty offered increases demand increases.
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Two effects when a monopoly increases the qty
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1. the output effect: More output is sold, so Q is higher, which tends to increase total revenue
2. The price effect: the price falls, so P is lower, which tends to decrease total revenue.
2. The price effect: the price falls, so P is lower, which tends to decrease total revenue.
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Price discrimination
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the business practice of selling the same good at different prices to different customers.
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arbitrage
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the process of buying a good in one market at a low price and selling it in another market at a higher price (for profit)
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perfect price discrimination
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a situation in which the monopolist knows exactly the willingness to pay each customer and can charge each customer a different price. AKA - First Degree price discrimination
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second-degree price discrimination
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charging different prices to the same customer for different units that the customer buys
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third-degree price discrimination
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achieved when the market can be segmented and when the segments have different elastics of demand.
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4 ways governments can respond to the problem of monopoly
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1. trying to make monopolized industries more competitive
2. regulating behaviour of the monopoly
3. turning some private monopolies into public enterprises.
4. by doing nothing at all.
2. regulating behaviour of the monopoly
3. turning some private monopolies into public enterprises.
4. by doing nothing at all.
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Economies of Scale
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factors that cause a producer's average cost per unit to fall as output rises
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imperfect competition
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a market structure that does not meet the conditions of perfect competition. Falls somewhere between the polar opposite of perfectly competition and monopoly.
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concentration ratio
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the percentage of the market's total output supplied by its four largest firms
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monopolistic competition
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a market structure in which many firms sell products that are similar but not identical
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Attributes of Monopolistic Competition
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many sellers, product differentiation, free entry and exit
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Four types of market structure
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1) Price exceeds marginal cost.
2) Price equals average total cost.
2) Price equals average total cost.
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Two Characteristics to describe long-run equilibrium in a monopolistically competitive market
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the quantity of output that minimizes average total cost
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efficiency scale
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the amount by which the efficient scale exceeds the quantity that the firm produces. Noteworthy difference between Monoploastic and Perfectly Competitive
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excess capacity
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under monopolistic competition, P > MC; under perfect competition, P = MC.
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markup over Marginal Cost
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consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys positive externality on consumers
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product-variety externality
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other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms.
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the business-stealing externality
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1) product-varitey externality
2) business-stealing externality
2) business-stealing externality
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two effects that are external to firms entering monopolastic market
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used to manipulate consumers tastes, creating a desire that otherwise would not exist.
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Critique of Advertising
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firms use advertising to provide information to consumers, and fosters competition.
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Defence of Advertising
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a market structure in which only a few sellers offer similar or identical products
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Oligopoly
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the study of how people behave in strategic situations
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Game Theory
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an agreement among firms in a market about quantities to produce or prices to charge
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collusion
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a group of firms acting in unison
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Cartel
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a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen
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Nash Equilibrium
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Because price is above marginal cost, selling 1 more litre of water at the going price will raise profit.
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Output effect
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Raising production will increase the total amount sold, which will lower the price and lower the profit on all the other litres sold.
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Price Effect
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a particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial
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Prisoner's Dilemma
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a strategy that is best for a player in a game regardless of the strategies chosen by the other players
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Dominate Strategy
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the inputs used to produce goods and services
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factors of production
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the relationship between the quantity of inputs used to make a good and the quantity of output of that good
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Production function
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the increase in the amount of output from an additional unit of labour
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Marginal product labour
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the marginal product of an input times the price of the output
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value of the marginal
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