Econ 540 test 2 - Assignment Essays

question

Explicit costs

answer

direct, out of pocket payments for inputs

question

Implicit costs

answer

reflect only a foregone opportunity rather than explicit, current expenditure

question

Opportunity cost

answer

value of the best alternative use of that resource

question

opportunity cost of a managers time

answer

amount she could make elsewhere

question

durable inputs

answer

are usable for a long period, perhaps many years
- Capital like land, building or equipment are examples

question

2 problems with accounting for the cost of durable inputs

answer

- how to distribute the initial purchase cost over time
- how to handle changes in the durable goods value

question

sunk costs

answer

past expenditure that cannot be recovered
- aren't considered in any managerial decisions

question

Managers should ignore sunk costs

answer

they should not consider in decision making and not count in opportunity costs

question

fixed cost

answer

does not vary with the level of output
- land, office space, production facilities, overhead

question

Variable Cost

answer

changes as the quantity of output changes; it's the costs of variable inputs

question

Total cost

answer

the sum of the fixed and variable costs

question

Average fixed cost

answer

equals fixed cost divided by output
- AFC falls as output rises because the fixed costs is spread over more units

question

Average variable cost

answer

equals variable cost divided by output
- AVC may increase or decrease as output rises

question

Average total cost

answer

equals total cost divided by output
- ATC may increase or decrease as output rises

question

Marginal cost

answer

amount by which a firm's cost changes when the firm produces one more unit of output
-MC = Change TC/Change Q
- MC = Change VC/Change Q

question

Marginal cost

answer

equals the change in variable cost from a one-unit increase in output

question

In the short run, a firm increases output by using more labor

answer

- each extra worker increases output by a smaller amount
- diminishing marginal returns to labor determine the shape of the protection function

question

marginal cost curve

answer

u-shaped and its specifics depend on diminishing marginal returns
- SR capital is fixed

question

average total cost

answer

calculated as total cost divided by quantity produced (TC/Q)
- curve is U-shaped
- SR capital is fixed

question

cost associated with fixed inputs

answer

is fixed

question

cost associated with variable inputs

answer

we can adjust and are variable

question

diminishing marginal returns

answer

the variable and total cost curves become relatively steep as output increases
- ATC, AVC, MC cost curves rise with output when diminishing marginal returns exist

question

lower MC values

answer

pulls down average values

question

higher MC values

answer

push up average values

question

technically efficient

answer

bundles of inputs use of few inputs as possible to produce a given quantity

question

economically efficient

answer

combination of inputs is that bundle of inputs with the lowest cost of production

question

isocost

answer

represents all the combinations of inputs that have the same total cost

question

properties of isocost

answer

- hits each axis at the value that represents the maximum of that input the firm can buy, given the total cost
- isocost further from the orgin represent higher total costs
- the slope of each isocost is the same (change in K/ change in L = w/r

question

minimize costs

answer

the firm minimizes its cost by using the combination of inputs on the isoquant that is on the lowest isocost line that still touches the isoquant

question

the lowest isocost rule

answer

the firm minimizes its cost by using the combination of inputs on the isoquant that is on the lowest isocost line that touches the isoquant

question

the tangency rule

answer

MRTS = -w/r
- at the minimum cost bundle, x, the isoquant is tangent to the isocost line. the slope of the isoquant (MRTS) and the slope of the isocost are equal

question

the last dollar rule

answer

MPL/w = MPK/r
- cost is minimized if inputs are chosen so that the last dollar spend on labor adds as much extra output as the last dollar spend on capital

question

what happens when factor (input) prices change

answer

if one input becomes relatively cheaper, the firm should substitute factors if possible

question

returns to scale

answer

in the long run, returns to scale determine the shape of the production function, and the production function, in turn, determines the shape of the average cost and other cost curves

question

a u-shaped LR average cost curve indicates varying returns to scale

answer

IRS at low levels of input, CRS at intermediate levels, DRS at high levels

question

LR average cost curve

answer

can take other forms especially in less competitive firms

question

less competitive firms have

answer

u-shaped, L-shaped, consistently downward-sloping, consistently upward sloping,, or several other types of LRAC curves

question

learning by doing

answer

refers to the productive skills and knowledge the workers and managers gain from experience

question

the learning curve

answer

the relationship between average cost and cumulative output

question

cumulative output

answer

total number of units of output produced product was introduced

question

economies of scale

answer

decreasing average costs as q increases

question

economies of scope

answer

decreasing average cost as q diversifies

question

perfect competition

answer

- very large number of relatively small firms
- standardized product
- market entry and exit is very easy
- non price competition is impossible
- market power is none
- LR economic profit is none

question

monopolistic competition

answer

- large number of relatively small firms
- type of product is differentiated
- market entry and exit is easy
- non price competition is possible
- market power is low to high
- long run economic profit is none

question

oligopoly

answer

- small number of relatively large firms
- the product is standardized of differentiated
- market entry and exit is difficult
- non price competition is possible or difficult
- market power is low to high
- LR economic profit is low to high *subject to mutual interdependence

question

monopoly

answer

- one firm
- type of product is unique
- market entry and exit very difficult or impossible
- non price competition not necessary
- market power is high
- LR economic profit high *subject to regulation

question

ability of firms to control the price of their product

answer

is the single most important indicator of how competitive a market structure is

question

price takers

answer

under perfect competition, there are so many firms and products are so identical that all firms are price takers, with not pricing power

question

price maker

answer

under pure monopoly, there is one firm with ultimate pricing power - the ultimate price maker

question

barriers to entry

answer

a pure monopoly may be able to utilize barriers to entry to keep LR economic profits positive

question

when a firm enters a market, it answers the following questions

answer

- how much should we produce?
- if we produce that amount, how much profit will we earn?
- if a loss rather than a profit is incurred will it be worthwhile to continue in this market in the long run or should we exit?

question

assumptions of how perfectly competitive firm makes production decisions

answer

- true price taker
- makes the distinction between SR and LR and plans accordingly
- firm's goal to maximize profits in the SR, and if it cannot earn profits, it seeks to minimize its losses
- the firm's costs includes not only costs paid to others but also opportunity cost of operating in the market when making production and other decisions

question

total revenue

answer

TR = P * Q

question

Average Revenue (AR)

answer

AR = TR/Q = P

question

Marginal Revenue (MR)

answer

MR = change in TR / change in Q

question

perfectly competitive firm's demand curve

answer

- faces a perfectly elastic demand curve, horizontal at the market price
- customers are willing to buy as much as the firm is willing to sell at the market price
- the demand curve is also the marginal revenue curve; marginal revenue for the firm is simply the products price
- and since AR = TR/Q and TR=PQ, P also equals AR

question

MR=MC restated

answer

restated as the P = MC rule for perfectly competitive firms
- emphasize marginal analysis as opposed to looking at total values
- the table to the left represents marginal cost and revenue data for the firm

question

MR=MC rule

answer

a firm that wants to maximize profits/ minimize losses should produce where MR = MC

question

profit per unit

answer

P-ATC

question

Total profit

answer

(P-ATC)*Q

question

shutdown

answer

a short run decision not to produce anything because of market conditions

question

exit

answer

long run decision to leave the market

question

difference between shutdown and exit

answer

if we shut down in the SR we still must pay FC but if we exit in the LR we won't have to pay FC

question

SR shut down rule

answer

if P < min AVC, shut down in the SR
- if P>AVC then firm produces Q where P=MC
- if P<AVC then firm shuts down (produces Q=0)

question

cost of exiting the market

answer

revenue loss = TR

question

benefit of exiting the market

answer

cost savings = TC

question

firms exits when

answer

TR < TC
- divide both sides by Q to write the firms decision rule as
- exit if P < ATC

question

enter a market when

answer

P > ATC

question

economic profit invites entry of new firms...

answer

- shifts supply curve to the right
- puts downward pressure on price
- reduces profits to normal levels

question

economic loss causes exit of firms...

answer

- shifts the supply curve to the left
- puts upward pressure on price
- increases profits to normal levels

question

long run equilibrium

answer

where the process to entry or exit is complete - remaining firms earn zero economic profit

question

zero economic profit occurs when

answer

P = ATC

question

the LR market supply curve is horizontal if

answer

- all firms have identical costs
- costs do not change as other firms enter or exit the market

question

firms have different costs

answer

- as p rises, firms with lower costs enter the market before those with higher costs
- further increases in P make it worthwhile for higher cost firms to enter the market, which increases market quantity supplied
- LR market supply curve slopes upward

question

costs rise as firms enter the market

answer

- In some industries, the supply of a key input is limited (e.g., amount of land suitable for farming is fixed).
- The entry of new firms increases demand for this input, causing its price to rise.
- This increases all firms' costs.
- Hence, an increase in P is required to increase the market quantity supplied, so the supply curve is upward-sloping.

question

profit maximization

answer

MC = MR

question

perfect competiton

answer

P = MR

question

factors associated with low competition

answer

- price making
- barriers to entry
- differentiated products

question

monopolist as a price maker

answer

- the monopolist is the ultimate price maker
- monopolist can officially set any price they want
- demand will only bear prices up to a certain point

question

profit maximizing quanity

answer

where MR = MC

question

if a firm produced less than Q*

answer

MR > MC the firm can do better by producing more

question

if a firm produces more that Q*

answer

MC > MR the firm can do better by producing less

question

demand curve for a monopoly

answer

downward sloping

question

P and MR

answer

not equal for a monopoly

question

P and quantity move

answer

in opposite directions

question

to sell an additional unit

answer

monopolist must lower price

question

for monopolist

answer

P < MR

question

A monopolist can earn LR profits

answer

- key feature of monopoly is the existence of barriers to entry - something that prevents the LR process we saw with competitive firms
- monopoly has something that blocks this process - a barrier

question

barriers to entry can be

answer

set up and maintained by the monopoly intentionally

question

technical barriers to entry

answer

exist when there are high start up costs

question

legal barriers to entry

answer

may exist in several forms
- can exist due to the structure of costs

question

natural monopoly

answer

exists when one firm can service a market more cheaply than several firms can

question

monopoly supply "curve"

answer

the closest that a monopoly has to a supply curve is that single point on the demand curve corresponding to Q*

question

Monopoly rents

answer

- economic profits go to normal (0) levels when new firms freely enter in response to SR profits
- maintain profits even into the log run
- long run profits are the monopoly rents
- return on the factor that forms the basis of the monopoly
- monopoly can maintain profits in the LR but no guarantee

question

Monopoly power

answer

the ability to raise price above marginal cost
- not all monopolies earn profits

question

distributional effects

answer

the idea that economic profits go to the wealthy making the rich richer and the poor poorer

question

monopolistic competiton

answer

many firms, relatively easy to entry of new firms in the LR and price and quantity decisions are just like a monopoly

question

demand curves shape

answer

- when the demand curve is steep, demand is overall inelastic
- when demand curve is flat, demand is overall elastic

question

Profit maximizing price

answer

p = (1/1+(1/E))MC

question

lerner index

answer

- measures a firms market power
- (p-MC)/p
- the larger the difference between price and marginal cost, the larger the lerner index
- can be calcuated for any firm

question

lerner index when profits are maximized

answer

- (p-MC)/p = -1/E
- the lerner index or price markup for a monopoly ranges between 0 and 1
-as elasticity of demand falls, the lerner index goes up

question

things that tend to reduce market power

answer

- less power with better substitutes (demand becomes more elastic)
- less power with more firms (more choices)
- less power with closer competitors (demand becomes more elastic)

question

cost advantage monopoly

answer

- low cost firm is a monopoly if it sells at a price so low that other potential competitors with higher costs would lose money. no other firm enters the market
- the sources of cost advantage over potential rivals are diverse: superior technology, better way of organizing production, control of an essential facility, or control of a scarce resource

question

natural monopoly

answer

- one firm that can serve the entire market at a lower per-unit cost than two or more firms can
- economies of scale explain this outcome: a natural monopoly has the same strictly declining average cost curve
- when one firm is the cheapest way to produce any given output level, governments often grant monopoly rights to public utilities of water, gas, electric power, or mail delivery

question

license to operate

answer

governments create monopolies either by making it difficult for new firms to obain

question

patent

answer

exclusive right granted to the inventor of a new and useful product, process, substance, or design for a specified length of time

question

what price discrimination is

answer

charging different prices to different customers, or different groups of customers

question

how price discrimination pays

answer

- for almost any good or service, some consumers are willing to pay more than others
- price discrimination increases profit above the uniform pricing level through two channels

question

higher prices for some

answer

price discrimination can extract additional consumer surplus from consumers who place a high value on the good

question

attract new customers

answer

price discrimination can simultaneously sell to new customers who would not be willing to pay the maximizing uniform price

1 of 110

question

Explicit costs

answer

direct, out of pocket payments for inputs

question

Implicit costs

answer

reflect only a foregone opportunity rather than explicit, current expenditure

question

Opportunity cost

answer

value of the best alternative use of that resource

question

opportunity cost of a managers time

answer

amount she could make elsewhere

question

durable inputs

answer

are usable for a long period, perhaps many years
- Capital like land, building or equipment are examples

question

2 problems with accounting for the cost of durable inputs

answer

- how to distribute the initial purchase cost over time
- how to handle changes in the durable goods value

question

sunk costs

answer

past expenditure that cannot be recovered
- aren't considered in any managerial decisions

question

Managers should ignore sunk costs

answer

they should not consider in decision making and not count in opportunity costs

question

fixed cost

answer

does not vary with the level of output
- land, office space, production facilities, overhead

question

Variable Cost

answer

changes as the quantity of output changes; it's the costs of variable inputs

question

Total cost

answer

the sum of the fixed and variable costs

question

Average fixed cost

answer

equals fixed cost divided by output
- AFC falls as output rises because the fixed costs is spread over more units

question

Average variable cost

answer

equals variable cost divided by output
- AVC may increase or decrease as output rises

question

Average total cost

answer

equals total cost divided by output
- ATC may increase or decrease as output rises

question

Marginal cost

answer

amount by which a firm's cost changes when the firm produces one more unit of output
-MC = Change TC/Change Q
- MC = Change VC/Change Q

question

Marginal cost

answer

equals the change in variable cost from a one-unit increase in output

question

In the short run, a firm increases output by using more labor

answer

- each extra worker increases output by a smaller amount
- diminishing marginal returns to labor determine the shape of the protection function

question

marginal cost curve

answer

u-shaped and its specifics depend on diminishing marginal returns
- SR capital is fixed

question

average total cost

answer

calculated as total cost divided by quantity produced (TC/Q)
- curve is U-shaped
- SR capital is fixed

question

cost associated with fixed inputs

answer

is fixed

question

cost associated with variable inputs

answer

we can adjust and are variable

question

diminishing marginal returns

answer

the variable and total cost curves become relatively steep as output increases
- ATC, AVC, MC cost curves rise with output when diminishing marginal returns exist

question

lower MC values

answer

pulls down average values

question

higher MC values

answer

push up average values

question

technically efficient

answer

bundles of inputs use of few inputs as possible to produce a given quantity

question

economically efficient

answer

combination of inputs is that bundle of inputs with the lowest cost of production

question

isocost

answer

represents all the combinations of inputs that have the same total cost

question

properties of isocost

answer

question

minimize costs

answer

the firm minimizes its cost by using the combination of inputs on the isoquant that is on the lowest isocost line that still touches the isoquant

question

the lowest isocost rule

answer

the firm minimizes its cost by using the combination of inputs on the isoquant that is on the lowest isocost line that touches the isoquant

question

the tangency rule

answer

MRTS = -w/r
- at the minimum cost bundle, x, the isoquant is tangent to the isocost line. the slope of the isoquant (MRTS) and the slope of the isocost are equal

question

the last dollar rule

answer

MPL/w = MPK/r
- cost is minimized if inputs are chosen so that the last dollar spend on labor adds as much extra output as the last dollar spend on capital

question

what happens when factor (input) prices change

answer

if one input becomes relatively cheaper, the firm should substitute factors if possible

question

returns to scale

answer

in the long run, returns to scale determine the shape of the production function, and the production function, in turn, determines the shape of the average cost and other cost curves

question

a u-shaped LR average cost curve indicates varying returns to scale

answer

IRS at low levels of input, CRS at intermediate levels, DRS at high levels

question

LR average cost curve

answer

can take other forms especially in less competitive firms

question

less competitive firms have

answer

u-shaped, L-shaped, consistently downward-sloping, consistently upward sloping,, or several other types of LRAC curves

question

learning by doing

answer

refers to the productive skills and knowledge the workers and managers gain from experience

question

the learning curve

answer

the relationship between average cost and cumulative output

question

cumulative output

answer

total number of units of output produced product was introduced

question

economies of scale

answer

decreasing average costs as q increases

question

economies of scope

answer

decreasing average cost as q diversifies

question

perfect competition

answer

- very large number of relatively small firms
- standardized product
- market entry and exit is very easy
- non price competition is impossible
- market power is none
- LR economic profit is none

question

monopolistic competition

answer

question

oligopoly

answer

question

monopoly

answer

question

ability of firms to control the price of their product

answer

is the single most important indicator of how competitive a market structure is

question

price takers

answer

under perfect competition, there are so many firms and products are so identical that all firms are price takers, with not pricing power

question

price maker

answer

under pure monopoly, there is one firm with ultimate pricing power - the ultimate price maker

question

barriers to entry

answer

a pure monopoly may be able to utilize barriers to entry to keep LR economic profits positive

question

when a firm enters a market, it answers the following questions

answer

question

assumptions of how perfectly competitive firm makes production decisions

answer

question

total revenue

answer

TR = P * Q

question

Average Revenue (AR)

answer

AR = TR/Q = P

question

Marginal Revenue (MR)

answer

MR = change in TR / change in Q

question

perfectly competitive firm's demand curve

answer

question

MR=MC restated

answer

question

MR=MC rule

answer

a firm that wants to maximize profits/ minimize losses should produce where MR = MC

question

profit per unit

answer

P-ATC

question

Total profit

answer

(P-ATC)*Q

question

shutdown

answer

a short run decision not to produce anything because of market conditions

question

exit

answer

long run decision to leave the market

question

difference between shutdown and exit

answer

if we shut down in the SR we still must pay FC but if we exit in the LR we won't have to pay FC

question

SR shut down rule

answer

if P < min AVC, shut down in the SR
- if P>AVC then firm produces Q where P=MC
- if P<AVC then firm shuts down (produces Q=0)

question

cost of exiting the market

answer

revenue loss = TR

question

benefit of exiting the market

answer

cost savings = TC

question

firms exits when

answer

TR < TC
- divide both sides by Q to write the firms decision rule as
- exit if P < ATC

question

enter a market when

answer

P > ATC

question

economic profit invites entry of new firms...

answer

- shifts supply curve to the right
- puts downward pressure on price
- reduces profits to normal levels

question

economic loss causes exit of firms...

answer

- shifts the supply curve to the left
- puts upward pressure on price
- increases profits to normal levels

question

long run equilibrium

answer

where the process to entry or exit is complete - remaining firms earn zero economic profit

question

zero economic profit occurs when

answer

P = ATC

question

the LR market supply curve is horizontal if

answer

- all firms have identical costs
- costs do not change as other firms enter or exit the market

question

firms have different costs

answer

question

costs rise as firms enter the market

answer

question

profit maximization

answer

MC = MR

question

perfect competiton

answer

P = MR

question

factors associated with low competition

answer

- price making
- barriers to entry
- differentiated products

question

monopolist as a price maker

answer

- the monopolist is the ultimate price maker
- monopolist can officially set any price they want
- demand will only bear prices up to a certain point

question

profit maximizing quanity

answer

where MR = MC

question

if a firm produced less than Q*

answer

MR > MC the firm can do better by producing more

question

if a firm produces more that Q*

answer

MC > MR the firm can do better by producing less

question

demand curve for a monopoly

answer

downward sloping

question

P and MR

answer

not equal for a monopoly

question

P and quantity move

answer

in opposite directions

question

to sell an additional unit

answer

monopolist must lower price

question

for monopolist

answer

P < MR

question

A monopolist can earn LR profits

answer

- key feature of monopoly is the existence of barriers to entry - something that prevents the LR process we saw with competitive firms
- monopoly has something that blocks this process - a barrier

question

barriers to entry can be

answer

set up and maintained by the monopoly intentionally

question

technical barriers to entry

answer

exist when there are high start up costs

question

legal barriers to entry

answer

may exist in several forms
- can exist due to the structure of costs

question

natural monopoly

answer

exists when one firm can service a market more cheaply than several firms can

question

monopoly supply "curve"

answer

the closest that a monopoly has to a supply curve is that single point on the demand curve corresponding to Q*

question

Monopoly rents

answer

question

Monopoly power

answer

the ability to raise price above marginal cost
- not all monopolies earn profits

question

distributional effects

answer

the idea that economic profits go to the wealthy making the rich richer and the poor poorer

question

monopolistic competiton

answer

many firms, relatively easy to entry of new firms in the LR and price and quantity decisions are just like a monopoly

question

demand curves shape

answer

- when the demand curve is steep, demand is overall inelastic
- when demand curve is flat, demand is overall elastic

question

Profit maximizing price

answer

p = (1/1+(1/E))MC

question

lerner index

answer

- measures a firms market power
- (p-MC)/p
- the larger the difference between price and marginal cost, the larger the lerner index
- can be calcuated for any firm

question

lerner index when profits are maximized

answer

- (p-MC)/p = -1/E
- the lerner index or price markup for a monopoly ranges between 0 and 1
-as elasticity of demand falls, the lerner index goes up

question

things that tend to reduce market power

answer

- less power with better substitutes (demand becomes more elastic)
- less power with more firms (more choices)
- less power with closer competitors (demand becomes more elastic)

question

cost advantage monopoly

answer

question

natural monopoly

answer

question

license to operate

answer

governments create monopolies either by making it difficult for new firms to obain

question

patent

answer

exclusive right granted to the inventor of a new and useful product, process, substance, or design for a specified length of time

question

what price discrimination is

answer

charging different prices to different customers, or different groups of customers

question

how price discrimination pays

answer

- for almost any good or service, some consumers are willing to pay more than others
- price discrimination increases profit above the uniform pricing level through two channels

question

higher prices for some

answer

price discrimination can extract additional consumer surplus from consumers who place a high value on the good

question

attract new customers

answer

price discrimination can simultaneously sell to new customers who would not be willing to pay the maximizing uniform price

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