question
competition and profits
answer
all firms are in business to make a profit.
their profit opportunities are limited by the amount of competition they face.
-little competition, easier to be profitable.
-lots of competition, much more difficult.
their profit opportunities are limited by the amount of competition they face.
-little competition, easier to be profitable.
-lots of competition, much more difficult.
question
the profit motive
answer
the expectation of profit is the basic incentive to produce.
the profit motive encourages firms to produce the goods and services that consumers desire, at prices they are willing to pay.
-what will happen to a firm if it produces goods that no consumers want or are willing to pay for?
-it encourages firms to produce products customers desire at prices they are willing to pay.
-it causes markets to adapt to changing economic conditions and customer preferences.
the profit motive encourages firms to produce the goods and services that consumers desire, at prices they are willing to pay.
-what will happen to a firm if it produces goods that no consumers want or are willing to pay for?
-it encourages firms to produce products customers desire at prices they are willing to pay.
-it causes markets to adapt to changing economic conditions and customer preferences.
question
Profit
answer
the difference between total revenue and total cost
question
economic vs. accounting profits
answer
economists include all costs in economic costs, both implicit costs and explicit costs.
accountants include only explicit costs.
-economic profit, then, is smaller than accounting profit because more costs are subtracted.
accountants include only explicit costs.
-economic profit, then, is smaller than accounting profit because more costs are subtracted.
question
normal profit
answer
the opportunity cost of capital.
-the owner could have invested these resources elsewhere. if the opportunity cost is a lost return of 10%, then the owner will expect at least a 10% return in this business, preferably higher.
-normal profit is the equivalent to an implicit cost.
-it is earned if the economic profit is zero, which, surprisingly, is the typical case.
a productive activity reaps and economic profit only if it earns more than its opportunity cost.
-the owner could have invested these resources elsewhere. if the opportunity cost is a lost return of 10%, then the owner will expect at least a 10% return in this business, preferably higher.
-normal profit is the equivalent to an implicit cost.
-it is earned if the economic profit is zero, which, surprisingly, is the typical case.
a productive activity reaps and economic profit only if it earns more than its opportunity cost.
question
entrepreneurship and risk
answer
the entrepreneur will go into business only if the prospect of earning more there is greater than the alternative use of resources.
-the owner expects a return of more than a normal profit.
-there is no guarantee of a profit. thus the owner is willing to undertake the risk of suffering economic losses.
-the inducement to face this risk is the potential for economic profit.
-the owner expects a return of more than a normal profit.
-there is no guarantee of a profit. thus the owner is willing to undertake the risk of suffering economic losses.
-the inducement to face this risk is the potential for economic profit.
question
market structure
answer
the number and relative size of firms in the industry.
the market structures range from monopoly at one extreme to perfect competition at the other extreme. most real-world firms are along the continuum of imperfect competition.
the market structures range from monopoly at one extreme to perfect competition at the other extreme. most real-world firms are along the continuum of imperfect competition.
question
perfect competition
answer
a market in which no buyer or seller has market power
-many firms compete for consumer purchases.
-the products of each firm are identical
-low entry barriers make it easy to get into the business.
-no firm has any market power, thus they cannot manipulate the price. they are price takers.
-each firm's output is small relative to the total market amount.
-many firms compete for consumer purchases.
-the products of each firm are identical
-low entry barriers make it easy to get into the business.
-no firm has any market power, thus they cannot manipulate the price. they are price takers.
-each firm's output is small relative to the total market amount.
question
monopolistic competition
answer
many firms, a little market power
question
oligopoly
answer
a few firms, considerable market power
question
duopoly
answer
two firms
question
monopoly
answer
one firm only
question
market demand vs firm demand
answer
although the entire market has a typical downward-sloping demand curve, the individual firm perceives its demand curve to be horizontal
question
a firms demand curve
answer
why horizontal?
-the firm is a price taker. it will charge only the market price.
-if it raises its price, nobody will buy.
-if it lowers its price, it will sell out, but it can do that at the market price.
-it can sell increases quantities at the market price.
if you draw a line for any quantity at the market price, the line will be horizontal.
-the firm is a price taker. it will charge only the market price.
-if it raises its price, nobody will buy.
-if it lowers its price, it will sell out, but it can do that at the market price.
-it can sell increases quantities at the market price.
if you draw a line for any quantity at the market price, the line will be horizontal.
question
the production decision
answer
there are no pricing decisions. firms take the market price.
there are no quality decisions since all products are identical.
the only decision left is how much to produce.
there are no quality decisions since all products are identical.
the only decision left is how much to produce.
question
the production decision
answer
never produce a unit of output that yields less revenue than it costs.
as output increases, marginal cost (MC) increases, squeezing the profit from the added units.
compare P to MC
-if P > MC we add to profit by selling that one.
-If P < MC we make a loss by selling that one.
-if P=MC we make no profit or loss on that one.
as output increases, marginal cost (MC) increases, squeezing the profit from the added units.
compare P to MC
-if P > MC we add to profit by selling that one.
-If P < MC we make a loss by selling that one.
-if P=MC we make no profit or loss on that one.
question
marginal revenue (MR)
answer
is equal to price, the added amount received from selling one more unit.
question
profit maximization rule
answer
For perfectly competitive firms,
If P > MC, increase output and profits will grow.
If P < MC, decrease output and losses will go away.
If P = MC, produce this output because it is the quantity at which profits are maximized.
Profit maximization rule:
Produce at that rate of output where marginal revenue (MR = P) equals marginal cost (MC).
If P > MC, increase output and profits will grow.
If P < MC, decrease output and losses will go away.
If P = MC, produce this output because it is the quantity at which profits are maximized.
Profit maximization rule:
Produce at that rate of output where marginal revenue (MR = P) equals marginal cost (MC).
question
graphical look at profit maximization
answer
Here we relate ATC and MC to P=MR.
To maximize profits, choose the quantity related to point b. That is where MR=MC.
Note that it is not the same as maximum profit per unit (point a) or maximum revenues (point c).
To maximize profits, choose the quantity related to point b. That is where MR=MC.
Note that it is not the same as maximum profit per unit (point a) or maximum revenues (point c).
question
the shutdown decision
answer
Shutting down the firm does not eliminate all costs.
Fixed costs must be paid even if all output ceases.
If a firm makes losses, it cannot pay all its fixed costs and its variable costs.
The firm will lose less by shutting down (output=0) if losses from continuing production exceed fixed costs.
Fixed costs must be paid even if all output ceases.
If a firm makes losses, it cannot pay all its fixed costs and its variable costs.
The firm will lose less by shutting down (output=0) if losses from continuing production exceed fixed costs.
question
the investment decision
answer
Investment decision: the decision to build, buy, or lease plants and equipment or to enter or exit an industry.
The shutdown decision is a short-run decision.
Investment decisions are long-run.
Fixed costs are the owners' investment in the business. They must generate enough revenue to recoup the investment.
Investment will occur if the anticipated profits are large enough to compensate for the effort and risk.
The shutdown decision is a short-run decision.
Investment decisions are long-run.
Fixed costs are the owners' investment in the business. They must generate enough revenue to recoup the investment.
Investment will occur if the anticipated profits are large enough to compensate for the effort and risk.
question
determinants of supply
answer
A producer will increase output only if profits are increasing. Conversely, a producer will decrease output if profits are decreasing.
Each of these determinants affects a producer's willingness and ability to supply a product:
The price of factor inputs.
Technology.
Expectations.
Taxes and subsidies.
Each of these determinants affects a producer's willingness and ability to supply a product:
The price of factor inputs.
Technology.
Expectations.
Taxes and subsidies.
question
the short-run supply curve
answer
The supply curve shows the quantity a producer is willing to supply at each price.
The profit maximization rule leads us to the short-run supply curve.
At each price, the producer sets output where MR=MC.
The producer resets this output when price changes.
Raise the price, produce more.
Lower the price, produce less.
The marginal cost curve is the firm's short-run supply curve.
The profit maximization rule leads us to the short-run supply curve.
At each price, the producer sets output where MR=MC.
The producer resets this output when price changes.
Raise the price, produce more.
Lower the price, produce less.
The marginal cost curve is the firm's short-run supply curve.
question
supply shifts
answer
if any determinant of supply changes, the supply curve shifts.
-a change that lowers cost will cause the supply curve to shift right
-a change that raises costs will cause the supply curve to shift left
-a change that lowers cost will cause the supply curve to shift right
-a change that raises costs will cause the supply curve to shift left
question
tax effects
answer
raising property taxes
-fixed costs and total costs rise, but MC does not. so there is no change in the production decision
raising payroll taxes
-variable costs and total costs rise, but MC rises also. the MC curve will shift upward to the left, and production output will be decreased.
raising profit taxes
-neither fixed nor variable costs are changed. but owners receive less return and may reduce investment in new business.
-fixed costs and total costs rise, but MC does not. so there is no change in the production decision
raising payroll taxes
-variable costs and total costs rise, but MC rises also. the MC curve will shift upward to the left, and production output will be decreased.
raising profit taxes
-neither fixed nor variable costs are changed. but owners receive less return and may reduce investment in new business.
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