question
accounting profit
answer
total revenue - explicit costs
question
economic profit
answer
accounting profit - implicit costs or TR - TC (total revenue - total costs)
question
normal profit
answer
accounting profit required to keep entrepreneur in current venture
at normal profit, economic profit = 0 & total revenue = total economic cost
at normal profit, economic profit = 0 & total revenue = total economic cost
question
short run
answer
at least 1 fixed resource commitment
some resources are variable
output can change a little
some resources are variable
output can change a little
question
long run
answer
all resources are variable
firms can enter/exit industry
output can change a lot
firms can enter/exit industry
output can change a lot
question
Average Product (AP)
answer
TP/L
(TP = total product, L = quantity of labor)
average output produced per worker
(TP = total product, L = quantity of labor)
average output produced per worker
question
Marginal Product (MP)
answer
∆TP/∆L
(TP = total product, L = quantity of labor)
additional produced by hiring one more worker
(TP = total product, L = quantity of labor)
additional produced by hiring one more worker
question
What happens if to average product (AP) if MP > AP (marginal product > average product)?
answer
average product increases
question
What happens if marginal product < average product?
answer
average product decreases
question
increasing marginal returns
answer
MP rises, AP rises at increasing rate
question
diminishing marginal returns
answer
MP decreases, AP increases then decreases
question
negative marginal returns
answer
MP is negative, AP decreases
question
fixed costs
answer
Costs which stay the same at all levels of output in the short run.
question
Average Fixed Costs (AFC)
answer
AFC = TFC / Q
AFC = average fixed costs
TFC = total fixed costs
Q = quantity produced
AFC = average fixed costs
TFC = total fixed costs
Q = quantity produced
question
variable costs
answer
costs that can change
question
Average Variable Cost (AVC)
answer
AVC = TVC / Q
TVC = total variable cost
Q = quantity produced
TVC = total variable cost
Q = quantity produced
question
Total Cost (TC)
answer
TC = TFC + TVC
(total fixed cost + total variable cost)
(total fixed cost + total variable cost)
question
Average Total Cost (ATC)
answer
ATC = TC / Q = AFC + AVC
(total cost / quantity produced or average fixed cost + average variable cost)
(total cost / quantity produced or average fixed cost + average variable cost)
question
Marginal Cost (MC)
answer
MC = ∆TC / ∆Q
(change in total cost / change in quantity produced)
(change in total cost / change in quantity produced)
question
How does specialization affect MC (marginal cost) vs. Quantity graph
answer
causes graph to slope downward (at the beginning)
question
How does diminishing marginal returns affect MC (marginal cost) vs. Quantity graph?
answer
Cause graph to slope upward after certain point
question
How does specialization affect MP (marginal product) vs. Labor graph
answer
Causes graph to slope upward at beginnning
question
How does diminishing marginal returns affect MP (marginal product) vs. Labor graph
answer
Causes graph to slope downard after a certain point
question
Where does MC (marginal cost) curve intersect ATC (average total cost) & AVC (average variable cost) curves?
answer
At minimums of ATC & AVC curves
question
How to find AFC (Average fixed cost) from ATC (average total cost) & AVC (average variable cost) curves?
answer
distance between ATC & AVC curves
question
increasing returns to scale
answer
output increases by greater percentage than inputs
leads to economies of scale
leads to economies of scale
question
constant returns to scale
answer
output increases by same percentage as input
question
decreasing returns to scale
answer
outputs increase by smaller percentage than inputs
results in diseconomies of scale
results in diseconomies of scale
question
What happens to LRATC (long run average total cost) as Q increases for economics of scale (left end of LRATC graph?
answer
LRATC decreases
question
What happens to LRATC (long run average total cost) as Q increases for constant returns to scale (middle of LRATC graph)?
answer
LRATC stays constant
question
What happens to LRATC (long run average total cost) as Q increases for diseconomies of scale (right end of LRATC graph)?
answer
LRATC increases
question
causes of economies of scale
answer
specialization of labor & management
efficient capital (equipment)
significant 'start-up' costs
efficient capital (equipment)
significant 'start-up' costs
question
causes of diseconomies of scale
answer
inefficient communication and coordination
question
minimum efficient scale (MES)
answer
point at which LRATC is minimized (bottom of LRATC curve)
question
If extensive economies of scale exist, who will dominate industry?
answer
few large firms
question
If economies of scale are quickly exhausted who will dominate industry
answer
multiple small firms
question
When is profit maximized?
answer
When MR=MC
question
How do you know if a firm is making positive economic profit from price and ATC?
answer
P > ATC → positive economic profit
P < ATC → negative economic profit
P = ATC → zero economic profit
P < ATC → negative economic profit
P = ATC → zero economic profit
question
When does a firm shut down?
answer
When P < AVC
(Note: if AVC < P < ATC, company is losing money but still continues producing)
(Note: if AVC < P < ATC, company is losing money but still continues producing)
question
How to calculate profit/loss using firm graph
answer
Profit: area of gray rectangle in left graph below
Loss: area of pink rectangle in graph below
Or profit or loss = |P - ATC| × Q
where |P - ATC| = profit or loss per unit = distance between demand & price at which ATC intersects Q
Loss: area of pink rectangle in graph below
Or profit or loss = |P - ATC| × Q
where |P - ATC| = profit or loss per unit = distance between demand & price at which ATC intersects Q
question
What happens in LR if economic profit is positive in SR for perfectly competitive industry?
answer
new firms enter → supply increases →price decreases until normal profit
question
What happens in LR if economic profit is negative in SR in perfectly competitive indsutry?
answer
firms exit market → supply decreases
question
What happens in long run if there is zero economic profit?
answer
No incentive for firms to enter/exit market → long run equilibrium with firms earning normal profit
question
When is a market perfectly competitive?
answer
- Many small firms & consumers
- Standardized (homogenous) product
- Free entry/exit of firms in long run
- well-informed producers/consumers
- Standardized (homogenous) product
- Free entry/exit of firms in long run
- well-informed producers/consumers
question
How to draw individual firm's demand curve in perfectly competitive market?
answer
horizontal line at market price
question
Marginal Revenue (MR)
answer
MR = ∆TR / ∆Q
question
Total Revenue (TR)
answer
TR = P × Q
question
long run firm graph (perfect comp)
answer
supply shift in market graph causes shift in equilibrium price → shift in MR line on firm graph
normal profit at new MR
ATC, MC, & new MR all intersect at same point
allocatively efficient
normal profit at new MR
ATC, MC, & new MR all intersect at same point
allocatively efficient
question
How to determine whether firm has profit or loss using graph?
answer
ATC > D at given level of output → loss
ATC < D at given level of output → profit
ATC < D at given level of output → profit
question
Monopoly characteristics
answer
only one firm in industry
no close substitutes for product
firm is the market
Entry to industry blocked (even in LR) b/c of the following:
- cost advantages (economics of scale)
- legal barriers (patents/licences)
- control of essential resource
no close substitutes for product
firm is the market
Entry to industry blocked (even in LR) b/c of the following:
- cost advantages (economics of scale)
- legal barriers (patents/licences)
- control of essential resource
question
How to determine market quantity on monopoly graph
answer
draw vertical line going through intersection of MR & MC, see where it intersects horizontal axis
question
How to determine market price on monopoly graph
answer
draw horizontal line from intersection of vertical equilibrium quantity line & demand curve to vertical axis
question
How to determine if monopolist has profit or loss?
answer
ATC < D at equilibrium quantity → profit
ATC > D at equilibrium quantity → loss
ATC > D at equilibrium quantity → loss
question
How to calculate profit of monopolist?
answer
Area of rectangle bound by equilibrium quantity, equilibrium price, price axis, and horizontal line drawn from intersection of equilibrium quantity & ATC to price axis
question
How to calculate loss of monopolist?
answer
Area of rectangle bound by equilibrium quantity, equilibrium price, price axis, and horizontal line drawn from intersection of equilibrium quantity & ATC to price axis
question
How does monopoly affect price & quantity of output when compared to perfect competition?
answer
monopolists charge higher price than P.C. firm
monopolists produce less output than P.C. firm
(notice how Q1 < Q2 & P1 > P2 on graph)
monopolists produce less output than P.C. firm
(notice how Q1 < Q2 & P1 > P2 on graph)
question
deadweight loss of monopoly
answer
area bound by vertical line at given quantity, MC & D curves
question
Are monopolists productively efficient?
answer
No (they do not produce at quantity that minimizes ATC)
question
Do profit-maximizing monopolists operate in elastic or inelastic range of demand curve?
answer
elastic
question
Elastic range of demand for monopolist
answer
Everywhere left of where MR intersects Quantity axis
question
price discrimination
answer
charging different prices to different customers
question
What must firms have to price discriminate?
answer
some degree of monopoly power
ability to segment market
customers unable to resell product
ability to segment market
customers unable to resell product
question
perfect price discrimination
answer
charging every customer exactly what they are willing to pay
no DWL
no DWL
question
Differences between regular monopoly graph & perfect price discrimination graph
answer
With perfect price discrimination:
- D = MR
- more output
- greater profit
- no surplus/shortage
- no DWL
- D = MR
- more output
- greater profit
- no surplus/shortage
- no DWL
question
Characteristics of monopolistic competition
answer
- relatively large # of firms
- differentiated product
- easy entry/exit
- no collusion between firms
- each firm has small market shares
- firms take independent action
- firms have some control of price
- differentiated product
- easy entry/exit
- no collusion between firms
- each firm has small market shares
- firms take independent action
- firms have some control of price
question
SR monopolistic competition graph
answer
same as monopoly graph
question
LR monopolistic competition
answer
Firms enter/exit industry (depending on whether there is profit or loss in SR ) → D shifts left (if firms enter) or right (if firms exit) until D intersects ATC at quantity where MR = MC
zero economic profit in LR
zero economic profit in LR
question
Oligopoly Characteristics
answer
- few sellers
- products can be standardized or differentiated
- significant barriers to entry
- firms have some control over price
- mutual interdependence among firms (firms are influenced by other firms' actions)
- products can be standardized or differentiated
- significant barriers to entry
- firms have some control over price
- mutual interdependence among firms (firms are influenced by other firms' actions)
question
collusion
answer
working with other firms to set price/output levels
question
cartel
answer
group of firms colluding with each other
question
overt collusion
answer
working directly with other firms
question
covert collusion
answer
following decisions of other firms (indirect collusion)
question
dominant strategy
answer
strategy that is always better regardless of what other player does
(in picture below, low price is dominant strategy for both Andrew & Anna)
(in picture below, low price is dominant strategy for both Andrew & Anna)
question
Nash equilibrium
answer
outcome in which both players choose dominant (or weakly dominant) strategy (binding solution)
question
profit-maximizing price
answer
price at which MR = MC (unregulated on the graph)
question
fair-return price
answer
price at which ATC = D (normal profit)
question
socially optimal price
answer
price at which MC = D (allocatively efficient)
question
weakly dominant strategy
answer
strategy that is better given the other player's strategy
question
excess capacity
answer
Difference between ATC-minimizing quantity & quantity produced by firm
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