question
Elasticity
answer
How much one economic variable responds to changes in another economic variable
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price elasticity of demand
answer
measures how responsive the quantity demanded is to changes in price
question
What is the formula for price elasticity of demand?
answer
(percent change in quantity demanded)/(percent change in price)
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How do you find the percent change?
answer
new-old/old *100
question
Why can't elasticity be measured by the slope of the demand curve?
answer
The slope of the demand curve is based on units of measurement, so if you change to cents to dollars it will change. Using percentage changes allows for meaningful comparisons of demand responsiveness between different kinds of goods.
question
When is something considered elastic?
answer
when the price elasticity of demand is greater than 1 in absolute value
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What does it look like to be perfectly elastic? What is an example?
answer
Things that have plenty of options and replacements. Pizza, bread, books, pencils.
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When is something considered inelastic?
answer
when the price elasticity of demand is less than 1 in absolute value
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What does it look like to be perfectly inelastic. What is an example?
answer
Something that is perfectly inelastic has no substitutions. For ex. a life saving drug.
question
What is the midpoint formula?
answer
(x1+x2/2, y1+y2/2)
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How is the price elasticity of demand formula using the midpoint formula?
answer
first find Q and P separately: old-new/(x+y/2)
use the values you get from those and put Q/P *100
use the values you get from those and put Q/P *100
question
What are the key determinants of the price elasticity of demand for a product?
answer
-availability of close substitutes
-the passage of time
-whether the good is a necessity or a luxury
-how narrowly the market for the good is defined
-share of the good in the consumer's budget
-the passage of time
-whether the good is a necessity or a luxury
-how narrowly the market for the good is defined
-share of the good in the consumer's budget
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Which determinant is the most important?
answer
Usually the availability of substitutes for the products is the most important. If there are close substitutes, elasticity will be high because people can switch to buying another good as the product's price rises.
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What types of items are usually inelastic vs which are more elastic
answer
Necessities, like food, are usually inelastic/less elastic while demand for luxuries is more elastic
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Total revenue
answer
the total amount of funds received by a seller of a good or service
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When demand is inelastic, a decrease in price ______ total revenue and an increase in price ____ total revenue
answer
When demand is inelastic, a decrease in price reduced total revenue and an increase in price increase total revenue
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When demand is elastic, a decrease in price ______ total revenue and an increase in price ____ total revenue
answer
When demand is elastic, a decrease in price increase total revenue and an increase in price decreases total revenue
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What is the difference between the short run and the long run?
answer
In the short run, at least one of the firm's inputs is fixed, while in the long run, the firm can vary all of its inputs, adopt new technology, and change the size of physical plants.
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Is the amount of time that separates the short run from the long run the same for every firm?
answer
The amount of time that it takes a firm to move from the short run to the long run varies from firm to firm
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What are fixed costs?
answer
costs that remain constant as output changes.
Ex: a lease for a factory or retail store
Ex: a lease for a factory or retail store
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What are variable costs?
answer
costs that change as output changes.
Ex: cost of raw materials like pizza bought purchased by a pizza restaurant
Ex: cost of raw materials like pizza bought purchased by a pizza restaurant
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What is opportunity cost?
answer
The highest-valued alternative that must be given up to engage in an activity.
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What are implicit costs?
answer
non-monetary opportunity costs like wages the owner of a firm could have earned if they worked somewhere else
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What are explicit costs?
answer
costs that involve spending money
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When does the short-run production function hold constant?
answer
the short-run production function holds constant fixed inputs, such as number of oven in a pizza restaurant
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What is the production function?
answer
the relationship between the inputs employed by a firm and the maximum output it can produce with those inputs
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What is the marginal cost of production?
answer
The increase in total cost that results from producing another unit of output
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Why does the marginal cost curve have a U shape?
answer
When the marginal product of labor is rising, the marginal cost of output is falling, and when the marginal product of labor is falling, he marginal cost of output is rising
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What is the difference between the average total cost of production and the marginal cost of production?
answer
the ATC is the firms total cost divided by the quantity of output a firm produces. The MTC is the change in a firm's total cost from producing once more unit of a good or service
question
Where does the marginal curve intersect the average total cost curve? Why?
answer
When marginal cost is below ATC, MC pulls AC down so we are on the downward-sloping section of the U-shaped ATC. When MC is above ATC, MC pulls ATC up so we are on the upward-sloping section of the U-shaped curve. Therefore at the point where MC=ATC is the lowest point when the MC curve equals (or intersects) it
question
Can average total cost be decreasing over a range of output where marginal cost is increasing?
answer
Yes, as long as marginal cost is below average total cost, average total cost will be decreasing even if marginal cost is increasing
question
How do you calculate marginal cost?
answer
change in total cost / change in quantity
of the value before
of the value before
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For a graph for this unit, what is on the x axis? the y?
answer
Price on the x axis and quantity on the y
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What is the average fixed cost equal to?
answer
the fixed cost divided by the level of output
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What is average variable cost equal to?
answer
the variable cost divided by the level of output
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Where does the marginal cost curve intersect the average variable cost curve and the average total cost curve?
answer
the MC curve intersects the AVC curve and the ATC curve at their minimum points
question
AFC=
answer
ATC-AVC
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As the level of output increases, what happens to the difference between the value of average total cost and the value of average variable cost?
answer
ATC=AVC + AFC
so ATC-AVC = AFC
as AFC decreases so must ATC-AVC
so ATC-AVC = AFC
as AFC decreases so must ATC-AVC
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What happens to average fixed cost as output increases?
answer
Average fixed cost decreases as output increases
question
What shape is the marginal cost curve?
answer
kinda like a check mark
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What shape is the average total cost curve?
answer
the lowest cost at which a firm is able to produce a given level of output in the long run
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What shape is the average variable cost curve?
answer
a proportionate saving in costs gained by an increased level of production.
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What shape is the average fixed cost curve?
answer
the level of output at which all economies of scale have been exhausted. An automobile factory producing 200,000 cars per year has reached min efficient scale. It is where the long-run average cost curve stops sloping downward. If they produce less, they may have trouble surviving because they will be producing output at a higher cost than competitors.
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The long-run average cost curve shows . . .
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where long-run average cost curve is flat, gets to this point after economies of scale have been exhausted
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What are economies of scale?
answer
In the short run, total cost = variable cost + fixed cost. In the long run, total cost = variable cost because there are no fixed costs in the long run
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Minimum efficient scale
answer
In the long run, firms that don't reach minimum efficient scale will have higher average costs than competitors that do reach minimum efficient scale, so they will probably be driven out of business.
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constant returns to scale
answer
-a firm's technology may allow it to increase production with a smaller proportional increase in at least one input
-both workers and managers can become more specialized as output expands
-large firms may be able to purchase inputs at lower costs than smaller firms can
-as a firm expands, it may be able to borrow money at a lower interest rate, thereby lowering its costs
-both workers and managers can become more specialized as output expands
-large firms may be able to purchase inputs at lower costs than smaller firms can
-as a firm expands, it may be able to borrow money at a lower interest rate, thereby lowering its costs
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What is the difference between total cost and variable cost in the long run?
answer
when a firm's long-run average costs rise as the firm increases output.
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What is likely to happen in the long run to firms that do not reach minimum efficient scale?
answer
Diseconomies of scale eventually arise because managing a store or a factory above a certain size becomes more complicated and costly
question
What are four reasons that firms may experience economies of scale?
answer
because short-run average cost includes at least one input that is fixed in quantity, short-run average cost can never be less than long-run average cost (where there are no fixed inputs or fixed costs)
question
What are diseconomies of scale?
answer
Economies of scale often take the form of a larger store or restaurant allowing for lower average cost for a larger quantity but higher average total cost for a small quantity. For ex: when selling pizzas, a larger restaurant may use larger ovens, more tables, or other capital that isn't efficiently being used if a smaller quantity of pizzas is sold
question
What is the main reason that a firm eventually encounters diseconomies of scale as it keeps increasing the size of its store or factory?
answer
A market in which buyers and sellers are so many that no single one has any influence on market price and in which all the goods offered for sale are identical.
question
Why can short-run average cost never be less than long-run average cost for a given level of output?
answer
-must have many buyers and sellers
-firms must be producing identical products
-no barrier to new firms entering the market
-firms must be producing identical products
-no barrier to new firms entering the market
question
Why does the average total cost curve make a u-shape? Why is the price lower for higher quantities?
answer
a buyer or seller who cannot affect the market price.
question
What is a perfectly competitive market?
answer
Firms are likely to be price takers in perfectly competitive markets. Because a firm in a perfectly competitive market is very small relative to the market and because it is selling exactly the same product as other firms, it can sell as much as it wants to without having to lower its price. But if it tries to raise it, they will sell nothing because the customer has plenty of other lower price options that are the same.
question
What are the three conditions for a market to be perfectly competitive?
answer
The demand curve for the good or service is downward sloping. The demand curve for the output it a horizontal line at the market price.
question
What is a price taker?
answer
The units used in the market curve are much larger than the unit used in the individual firm's demand curve.
question
When are firms likely to be price takers?
answer
their sales drop to zero
question
What does a demand curve for a good or service in a perfectly competitive market look like? What about the demand curve for the output of one firm?
answer
total revenue - total cost (financial gain)
question
Why is the demand curve for the market downward sloping and the one for a specific firm horizontal?
answer
total revenue divided by the quantity of the product sold
question
What happens to firms if they attempt to charge more than the market price in a perfectly competitive market?
answer
By producing at a level where marginal revenue equals marginal cost. (MR=MC) This is where the difference between revenue and cost is the greatest.
question
What is profit?
answer
the change in total revenue from selling one more unit
question
What is average revenue (AR)
answer
P = MR = AR
question
How does a firm maximize profit?
answer
when the vertical distance between the line representing total revenue and the total cost curve is as large as possible
question
What is marginal revenue (MR)?
answer
In a perfectly competitive market, marginal revenue = price (MR=P). Making these two conditions for the profit-maximizing level of output equivalent.
question
In a perfectly competitive market Price = ?
answer
Profit = (P-ATC) * Q
question
When is profit maximized?
answer
ATC should be on top/higher than the AVC. Remember ATC is TOTAL cost, so it is going to be more money than the variable cost
question
Why is it true that for a firm in a perfectly competitive market, the profit-maximizing condition MR = MC is equivalent to the condition P = MC
answer
Where the demand (MR) line intersects with MC
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What is the formula for the relationship between total profit and average total cost?
answer
Because you don't want to miss out on any profit, which you would if you produce before that point
question
Where should the ATC curve be in relation to the AVC curve?
answer
loss is equal to total fixed costs which equals (ATC-AVC) * Q
question
Where do you draw the dotted line from when trying to draw the profit/loss line on a graph?
answer
a cost that has already been paid and that cannot be recovered
question
Why should a firm produce up to the point where marginal revenue equals marginal cost?
answer
In the short run, a firm will shut down if the price falls below the minimum point on its average variable cost curve. In the long run, a firm will shut down (and exit the industry) if the price is below the minimum point on its average total cost curve.
question
How do you determine a loss when a firm decides to shut down?
answer
The firm is willing to accept losses because it cannot do anything about its fixed costs and must pay those costs whether or not it is producing anything. (even if you shut down you're going to have to pay your lease for the rest of the year) In the long run, however, the firm will close down and exit the industry if it expects continued losses.
question
What is a sunk cost?
answer
The minimum point on the firm's average variable cost curve. If price falls below average variable cost, the firm shuts down in the short run.
question
What is the difference between a firm's shutdown point in the short run and in the long run?
answer
The perfectly competitive firm's supply curve can be directly derived from its marginal cost curve. The firm will produce where P=MC if price is at or above the shutdown point at the minimum point on the AVC curve
question
Why are firms willing to accept losses in the short run but not in the long run?
answer
the market supply curve is derived by adding up the quantity supplied (using marginal cost curves) by each firm in the market at each price
question
What is a perfectly competitive firm's shutdown point?
answer
a firm's revenues minus all its costs, implicit and explicit
question
What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?
answer
the situation in which a firm's total revenue is less that its total cost, including all implicit costs
question
How is the market supply curve derived from the supply curves of individual firms?
answer
when firms in an industry are earning economic profits
question
What is economic profit?
answer
when firms in an industry are suffering economic losses, some of those firms will exit the industry
question
What is economic loss?
answer
the situation in which the entry and exit of firms has resulted in the typical firm breaking even
question
When are firms likely to enter an industry?
answer
long-run supply curve shows the relationship between market price and the quantity supplied.
question
When are firms likely to exit an industry?
answer
In a perfectly competitive market it will be a horizontal line if it is a constant-cost industry (AC curves unchanged as industry expand/contracts). If firm is a decreasing cost industry, the long-run supply curve will slope downward.
question
What is long-run competitive equilibrium?
answer
Allocative efficiency is the state of the economy in which production reflects consumer preferences, specifically every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
question
What is the long-run supply curve?
answer
Productive efficiency is the situation in which a good or service is produced at the lowest possible average cost.
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What is the shape of the long-run supply curve in a perfectly competitive market?
answer
Productive efficiency refers to how a good or service is produced, while allocative efficiency refers to producing the goods and services that consumers value most
question
What is allocative efficiency?
answer
consumers purchase output up to the point where price equals marginal benefit. Under perfect competition, firms produce up to the point where price equals marginal cost. Perfect competition therefore, generates an equilibrium output where marginal benefit equals marginal cost, which represents allocative efficiency. In a perfectly competitive industry, free entry and exit ensures that, in the long run, firms are producing where average costs are minimized, thereby ensuring that productive efficiency also is achieved.
question
What is productive efficiency?
answer
Firms may temporarily earn greater profits from a reduction in costs, however in the long0run these profits lead to new firms entering the market. New firms shift the supply curve to the right, resulting in lower prices. Lower prices benefit consumers, but leave the typical firm just breaking even in the long run.
question
What is the difference between allocative and productive efficiency?
answer
a firm that is the only seller of a good or service that does not have a close substitute
question
How does perfect competition lead to allocative efficiency and productive efficiency?
answer
No, not is a close substitute for its product exists
question
Why don't firms benefit from cost reductions in perfectly competitive markets in the long-run but consumers do?
answer
a situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms
question
What is a monopoly?
answer
The most important ways a firm becomes a monopoly are through the following barrier to entry:
1) Gov blocks the entry of other firms into the market (patent, trademark etc)
2) Firm has control of a key resource
3) there are important network externalities in supplying the product
4) economies of scale are so large that one firm has a natural monopoly
1) Gov blocks the entry of other firms into the market (patent, trademark etc)
2) Firm has control of a key resource
3) there are important network externalities in supplying the product
4) economies of scale are so large that one firm has a natural monopoly
question
Can a firm be a monopoly if close substitutes for its product exist?
answer
the exclusive right to make a product for 20 years
question
What is a natural monopoly?
answer
the exclusive right to produce and sell a creation
question
What are the four most important ways a firm becomes a monopoly?
answer
grants a firm legal protection against other firms using its product's name
question
What is a patent?
answer
the right to be the only legal provider of a good or service
question
What is a copyright?
answer
It is doubtful that all or even most public franchises are natural monopolies. If they were, they wouldn't need the gov to restrict entry into their markets by other firms.
question
What is a trademark?
answer
because it expects that in the long run society will benefit from them. Profits firms hope to earn from a temporary monopoly encourage more rapid tech progress and encourage firms to take risks that they otherwise wouldn't
question
What is a public franchise?
answer
A firm doesn't need the gov to enact a law to bar entry of other firms, nor does it need to control a key resource. The monopoly occurs automatically, or naturally
question
Are all public franchises natural monopolies?
answer
a monopolist's demand curve is the market demand curve
question
If patents, copyright, and trademarks reduce competition, why does the federal government grant them?
answer
The marginal revenue curve is derived from the demand curve. For a linear demand curve, the marginal revenue curve will be below the demand curve. The marginal revenue curve is twice as steep as the demand curve because in absolute value, the slop of the marginal revenue curve will be twice the slope of the demand curve
question
What is "natural" about a natural monopoly?
answer
If a monopolist raises its price, it will lose some, but not all of its customers. Charging the highest price will not max profit because they would only sell one unit to the consumer willing to pay the highest possible price. To max profit, the monopolist charges a lower price, one that results in selling the quantity at which marginal revenue equals marginal cost.
question
What is the relationship between a monopolist's demand curve and the market demand curve?
answer
a monopoly charges a higher price and produces a smaller quantity, which reduces consumer surplus and economic efficiency
question
What is the relationship between a monopolist's demand curve and its marginal revenue curve?
answer
When firms can charge a price greater than marginal cost. It causes a loss in efficiency.
question
In what sense is a monopolist a price maker? Will charging the highest possible price always max monopolist's profit?
answer
1) The monopolist sets a price greater than marginal cost and therefore does not achieve allocative efficiency
2) the monopolist produces an output for which average total cost is not minimized and therefore does not achieve productive efficiency
2) the monopolist produces an output for which average total cost is not minimized and therefore does not achieve productive efficiency
question
Compared with a perfectly competitive industry, a monopoly charges a ___ price and produces a _______ quantity, which ______ consumer surplus and economic efficiency
answer
It allows for price to be set above marginal cost, which creates a deadweight loss because not every unit is produced for which the marginal benefit to consumers is greater than the marginal cost of production. But research suggests that total deadweight loss from market power is faily small.
question
What is market power?
answer
making agreement to charge the same price or otherwise not to compete
question
Why is society worse off when a monopolist charges a prices that earns monopoly profits rather than a price that is at the competitive level?
answer
law aimed at deterring monopoly, eliminating collusion, and promoting competition among firms
question
How does market power lead to deadweight loss?
answer
The Antitrust Division of the US Department of Justice and the Federal Trade Commission share responsibility for enforcing the antitrust law, including regulating mergers between firms
question
What is collusion?
answer
a merger between firms in the same industry (Ford and General Motors combine)
question
What are antitrust laws?
answer
A merger between firms at different levels of the production process (A car company buys a firm that makes mufflers)
question
Who is in charge of enforcing antitrust laws?
answer
Horizontal mergers are more likely to increase the market power of the newly merged firm because these mergers reduce the number of firms competing in the market for a particular good or service
question
What is a horizontal merger?
answer
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question
What is a vertical merger?
answer
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question
Which type of merger is more likely to increase the market power of a newly merged firm?
answer
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