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Fixed input (or factor)
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Any resource for which the quantity cannot change during the period under consideration. Can NOT change in the short run! They include the firm's management organization structure, level of technology, buildings and large equipment.
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Variable input (or factor)
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Any resource for which the quantity can change during the period under consideration. CAN change in the short run!
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Short run
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Short run is a period of time where there is at least one fixed input. This means that there are several periods of time that are considered a short-run time setting.
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Long run
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Long run is a period of time long enough to that all inputs are variable. Long run decisions are not easily reversed so usually a firm must live with the plant size that it has created for some time.
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Sunk cost
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The past cost of buying a plant that has no resale value.
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Production function
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The relationship between the maximum amounts of output that a firm can produce and carious quantities of inputs.
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Marginal product
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The change in total output produced by adding one unit of a variable input, with all other inputs used being held constant.
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Law of diminishing returns
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The principle that beyond some point the marginal product decreases as additional units of a variable factor are added to a fixed factor.
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Average product of a variable input
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The total output produce with a particular quantity of the variable input divided by the quantity of the variable input.
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Average product cruve
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The average product curve shows the average product that is produced adding a variable input at each level (or unit) of the variable input.
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Total Fixed Costs (TFC)
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Costs that do not vary as output varies and that must be paid even if output is zero.
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Total variable cost (TVC)
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Costs that are zero when output is zero and vary as output varies.
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Total Cost (TC)
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The sum of total fixed cost and total variable costs at each level of output.
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Average Fixed Cost (AFC)
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Total fixed cost divided by the quantity of output produced. AFC = TFC/Q.
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Average Variable Cost (AVC)
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The total variable cost divided by the quantity of output. AVC = TVC/Q.
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Average Total Cost (ATC)
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The total cost divided by the quantity of output. ATC = TC/Q.
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Marginal Cost
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The change, denoted as delta (triangle), in total cost when one additional unit of output is produced.
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If resource prices fall...?
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Then cost curves will shift downward.
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Higher taxes or more regulations will...?
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Will shift the cost curves upward.
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An increase in technology that allows more output to be produced from the same resources will...?
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Will shift the cost curves downward.
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Long-run marginal cost curve
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Is the additional cost of producing an additional unit of output when all inputs, including plant size, can be varied.
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Long-run average total cost
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The lowest per unit cost of producing any level of output when the sage of all inputs can be varied.
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A firm operates in the short run when...?
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When there is insufficient time to alter some fixed input. The firm plans in the long run when all inputs are variable.
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Economies of scale
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Is a situation in which the long-run average cost curve declines as the firm increases output.
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The main source of economies of scale?
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Is greater specialization of both labor and capital.
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Diseconomies of scale
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Is a situation in which the long-run average cost curve rises as the firm increases output.
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The main source of diseconomies of scale?
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Is the difficulty of managing a very large enterprise.
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Constant returns to scale
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Is a situation in which the long-run average cost curve does not change as the firm increases output.
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The minimum efficient scale
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Is the smallest quantity of output at which the long-run average cost curve reaches its lowest level.
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Market structure
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A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry into and exit from the market.
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Perfect competition occurs when?
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When the firms' minimum efficient scale are small relative to demand for the good or service (just means that there are many relatively small sellers), and when each firm is perceived to produce a good or service that have no unique characteristics, so consumers don't care from which firm they buy. Consumers see each firm's good in the industry as perfect substitutes.
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Characteristics of perfect competition:
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1. Large number of buyers, which implies that no single buyer can influence the market price.
2. Large number of relatively small firms, which implies that no single firm can influence the market price.
3. Homogenous product, which implies buyers are indifferent as to which seller's product they buy.
4. Consumers are price takers, which imply that a buyer has no control over the price of the product it sells.
5. Free entry and exit, which implies that resources be completely mobile to freely enter or exit a market.
6. Firms are price takers, implies that a seller has no control over the (maximum) price of the product it sells.
2. Large number of relatively small firms, which implies that no single firm can influence the market price.
3. Homogenous product, which implies buyers are indifferent as to which seller's product they buy.
4. Consumers are price takers, which imply that a buyer has no control over the price of the product it sells.
5. Free entry and exit, which implies that resources be completely mobile to freely enter or exit a market.
6. Firms are price takers, implies that a seller has no control over the (maximum) price of the product it sells.
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When should a firm shut down operation?
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If the market price is less than the firm's minimum AVC, the firm will shut down temporarily and incur a loss equal to total fixed cost.
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Where is the shut down point
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The shut down point is the level of output and price at which the firm's total revenues just cover its total variable cost.
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A short-run supply curve under perfect competition is...?
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the firm's marginal cost curve above the minimum point on its average variable cost curve.
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External Economies
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Are factors beyond the control of an individual firm that lower the firm's costs as the industry output increases. This type of industry is called a decreasing cost industry.
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External diseconomies
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Are factors beyond the control of a firm that raise the firm's costs as industry output increases. This type of industry is called an increasing cost industry.
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Constant-cost industry
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Is an industry in which the expansion of industry output by the entry of new firms has no effect on the individual firm's cost curve. The long-run supply curve in a perfectly competitive constant-cost industry is perfectly elastic.
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Decreasing cost industry
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Is an industry in which the expansion of industry output by the entry of new firms decreases the individual firm's cost curve. (Cost curve shifts downward and the industry experiences external economies.)
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Increasing cost industry
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Is an industry in which the expansion of industry output by the entry of new firms increases the individual firm's cost curve (cost curve shifts upward and the industry experiences external diseconomies.)
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Change in technology...
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Firms that adopt the new technology lower their costs and their supply curves shift rightward. In particular, the new technology marginal costs in the short-run decrease and their long run costs decrease. In the market, the price of the good falls, so that firms using the old technology incur economic losses.
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Old technology firms either...?
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They either adopt the new technology or else exit the industry. In the long run, all the firms, in our competitive market environment, use the new technology and earn zero economic profit.
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Monopolistic competition is a market structure in which the following is true:
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1. A large number of firms compete.
2. Each firm produces a differentiated product.
3. Firms compete on product quality, price, and marketing.
4. Firms are free to enter and exit the industry.
2. Each firm produces a differentiated product.
3. Firms compete on product quality, price, and marketing.
4. Firms are free to enter and exit the industry.
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Why can't firms in monopolistic competition make an economic profit?
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There are no barriers to entry in monopolistic competition.
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When does a firm have excess capacity?
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A firm has excess capacity if it produces less than the quantity at which ATC is a minimum.
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A firm's markup?
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A firm's markup is the amount by which its price exceed its marginal cost.
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In monopolistic competition, when is the amount of production development efficient?
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The amount of production development is efficient if the marginal social benefit from an innovation (which is the amount the consumer is willing to pay for the innovation) equals the marginal social cost that firms incur to make the innovation.
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The three characterizations of a monopoly market:
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1. Single Seller (in a particular market)
2. Unique product (or no close substitutes)
3. Very difficult or impossible entry into the market due to barriers to entry.
2. Unique product (or no close substitutes)
3. Very difficult or impossible entry into the market due to barriers to entry.
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Price Maker
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A firm that faces a downward-sloping demand curve and therefore it can choose among price and output combinations along the demand curve.
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Natural monopoly
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An industry in which the long-run average cost of production declines throughout the entire market.
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Describe the situation known as static inefficiency
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Since a monopoly market produces at a point where MAB>MSC it under produces and creates a deadweight loss. This result is known as having excess capacity in the market.
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Contrived scarcity
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A situation where a firm with market power produces a lower quantity than it would be produced in a competitive industry.
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Rent seeking
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Rent seeking can occur when someone uses resources seeking the opportunity to buy a monopoly for a price less than the monopoly's economic profit. Rent seeking also can occur when someone uses resources lobbying the government to restrict the competition faced by the lobbyist!
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Single-price monopoly
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A firm that sells each unit of its output for the same price to all its customers.
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Price discrimination
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The practice of selling different units of a good or service for different prices. Many firms price discriminate, but not all of them are monopoly firms.
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Conditions for price discrimination
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1. The seller must be a price maker
2. The seller must be able to segment the market
3. Consumers must not be able to engage in arbitrage (arbitrage is the practice of earning a profit by buying a good at a low price and reselling the good at a higher price)
2. The seller must be able to segment the market
3. Consumers must not be able to engage in arbitrage (arbitrage is the practice of earning a profit by buying a good at a low price and reselling the good at a higher price)
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Marginal cost pricing rule
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Sets price equal to marginal cost. This regulation results in an efficient use of resources but the firm's average total cost is greater than the price so the monopoly incurs an economic loss.
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Average cost pricing rule
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Sets price equal to average total cost. Because a normal profit is part of the firm's costs, the firm earns a normal profit. The amount of output is inefficient, though it is closer to the efficient quantity than when the monopoly is unregulated.
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Rate of return regulation
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Requires a firm to justify its price by showing that the price enables it to learn a specified target percent return on its capital.
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Price-cap regulation
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A price-cap regulation is a price ceiling -- a rule that specifies the highest price the firm is permitted to set and allows the firm to keep some (or all)of the cost savings.
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Oligopoly market structure
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Is characterized by an environment with only a few competitors (firms). The distinguishing features of an oligopoly are the presence of natural or legal barriers that prevent the entry of new firms and so only s small number of firms compete.
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Natural oligopoly
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Occurs when the efficient scale of production allows only a few firms to meet the market demand.
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Legal oligopoly
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Arises when a legal barrier to entry protects the small number of firms in the market.
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Why are firms in an oligopoly market interdependent?
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Because each firm's profit depends on its actions and the actions of its competitors
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Cartel
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A group of firms that act together or collude to limit output, raise price to increase their economic profits.
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Duopoly
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A market in which there are only two producers that compete.
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