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Profit
answer
Total Revenue - Total Cost
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Explicit Cost
answer
require an outlay of money
(paying wages to worker's)
(paying wages to worker's)
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Implicit Cost
answer
do not require a cash outlay
(opportunity cost of the owner's time)
(opportunity cost of the owner's time)
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Accounting Profit
answer
total revenue - total explicit costs *{higher than economic profit}+
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Economic Profit
answer
total revenue - total costs (explicit + implicit)
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Production Function
answer
shows the relationship b/w the quantity of inputs used to produce a good and the quantity of output of that good (table, graph, equation).
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Marginal Product
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the increase in output that arises from an additional unit of input
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Calculating Marginal Product of Labor (MPL)
answer
MPL = ΔQ/ΔL
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What is diminishing Marginal Product of Labor? (MPL) and why does it occur?
answer
The marginal product of an input declines as the quantity of the input increases
MPL diminishes as L rises whether the fixed input is land or capital (equipment, machines, etc.)
MPL diminishes as L rises whether the fixed input is land or capital (equipment, machines, etc.)
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FIXED COSTS (FC)
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do not vary with the quantity of output produced
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VARIABLE COSTS (VC)
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vary with the quantity produced
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TOTAL COST (TC):
answer
TC = FC + VC
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AVERAGE FIXED COST (AFC)
answer
AFC = FC / Q (AFC falls as Q rises: firms spread fixed costs over a larger and larger number of units)
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AVERAGE VARIABLE COST (AVC):
answer
AVC = VC / Q (As Q rises, AVC may fall initially. In most cases, AVC will eventually rise)
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AVERAGE TOTAL COST (ATC)
answer
ATC = TC / Q ; ATC = AFC + AVC
total cost divided by the quantity of output.
It represents the cost of a typical unit of output if total cost is divided evenly over all the units produced.
Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising.
total cost divided by the quantity of output.
It represents the cost of a typical unit of output if total cost is divided evenly over all the units produced.
Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising.
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MARGINAL COST (MC)
answer
MC = ΔTC / ΔQ
the amount that total cost rises when the firm increases production by 1 unit of output
the amount that total cost rises when the firm increases production by 1 unit of output
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study how FC, VC, TC, AFC, AVC, ATC and MC appear on a graph
answer
...
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Relationship between Marginal Cost and Average Total Cost and the Efficient Scale.
answer
MC is less than ATC = ATC is falling
MC is greater than ATC = ATC rising the MC curve crosses the ATC curve at the ATC curve's minimum
ATC is like your GPA, MC is like a one grade
MC is greater than ATC = ATC rising the MC curve crosses the ATC curve at the ATC curve's minimum
ATC is like your GPA, MC is like a one grade
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Inputs in the Short Run
answer
Some inputs are fixed (factories, land, etc.) The costs are Fixed Costs
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Inputs in the Long Run
answer
-All inputs are variable
-firms will choose the most profitable option
-firms will choose the most profitable option
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What are the 3 economies of scale?
answer
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
Constant Returns to Scale
Diseconomies of Scale
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Economies of Scale
answer
ATC falls as Quantity increases
-occur when increasing production allows greater specialization: workers more efficient when focusing on a narrow task (more common when Q is low)
-occur when increasing production allows greater specialization: workers more efficient when focusing on a narrow task (more common when Q is low)
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Constant Returns to Scale
answer
ATC stays the same as Q increases
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Diseconomies of Scale
answer
ATC rises as Q increases
due to coordination problems in large organizations; management becomes stressed, can't control costs (more common when Q is high)
due to coordination problems in large organizations; management becomes stressed, can't control costs (more common when Q is high)
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Price Taker
answer
each buyer and seller who takes the price as given
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Total Revenue (TR)
answer
TR = P × Q
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Average Revenue (AR)
answer
AR = TR / Q = P
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Marginal Revenue (MR)
answer
The change in TR from selling one more unit; MR = ΔTR / ΔQ
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GOLDEN RULE OF ECONOMICS
answer
MR = MC at the profit-maximizing Q
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Sunk Cost
answer
a cost that has already been committed and cannot be recovered
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Short-run decision to shut down:
answer
TR< VC (variable cost)
Price < Average Variable Cost (AVC)
the firm shuts down if the revenue that it would earn from producing is less than its variable costs of production.
Price < Average Variable Cost (AVC)
the firm shuts down if the revenue that it would earn from producing is less than its variable costs of production.
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Long-run decision to exit:
answer
TR< TC
P< ATC
P< ATC
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When would firms enter the market?
answer
P> ATC
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Perfectly Competitive Market:
answer
-many buyers and sellers
-goods are similar
-price takers
-free entry/exit
-goods are similar
-price takers
-free entry/exit
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Perfectly Competitive Firm:
answer
tries to maximize profit (total revenue minus total cost)
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Calculating Marginal Revenue (MR).
answer
MR = ΔTR / ΔQ
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Where does a firm maximize profit?
answer
when MC= MR
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Where does a firm minimize losses?
answer
When MC = MR even when making a loss
question
Solve for profit maximizing quantity, profit, and loss using a table or a graph.
answer
...
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Stay Open:
answer
P < ATC but P > AVC
(a short-run decision) to remain open and continue to produce when P is less than ATC but greater than AVC. (Still produce where MC=MR even when making a loss [loss is minimized])
(a short-run decision) to remain open and continue to produce when P is less than ATC but greater than AVC. (Still produce where MC=MR even when making a loss [loss is minimized])
question
Shutdown:
answer
A short-run decision not to produce anything because of market conditions
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Exit
answer
A long-run decision to leave the market [bankruptcy, liquidation]
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Short Run Supply Curve for the Perfectly Competitive Firm
answer
= MC > AVC
the competitive firm's supply curve is its marginal-cost curve above average variable cost. If the price falls below average variable cost, the firm is better off shutting down temporarily.
the competitive firm's supply curve is its marginal-cost curve above average variable cost. If the price falls below average variable cost, the firm is better off shutting down temporarily.
question
the Long Run Supply Curve for the Perfectly Competitive Firm.
answer
= MC > ATC
the competitive firm's supply curve is its marginal-cost curve above average total cost. If the price falls below average total cost, the firm is better off exiting the market.
the competitive firm's supply curve is its marginal-cost curve above average total cost. If the price falls below average total cost, the firm is better off exiting the market.
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What happens to the market and firm in the long run if there is profit or if there is losses?
answer
In the long run, the typical firm earns zero profit. b/c of the struggle b/w the firms and buyers, the profit will always be driven to zero
question
Zero Profit Condition (Long Run Equilibrium)
answer
-Firms can earn enough revenue to cover these costs
-Accounting profit is positive
-in the long run Price equals minimum ATC
-Accounting profit is positive
-in the long run Price equals minimum ATC
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Why is a perfectly competitive market efficient?
answer
The profit-maximizing quantity of output produced by a perfectly competitive firm results in the equality between price and marginal cost. In the short run, this involves the equality between price and short-run marginal cost. In the long run, this is seen with the equality between price and long-run marginal cost at the minimum efficient scale of production.
question
Market Power:
answer
the ability to influence the market price of the product it sells. [A competitive firm has no market power]
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Barriers to Entry:
answer
fixed costs that are too high for a new firm to be profitable
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Increasing Q has two effects on revenue for a monopolist's MR:
answer
output effect and price effect
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Output Effect
answer
higher output raises revenue
increases revenue
increases revenue
question
Price Effect
answer
lower price reduces revenue
decreases revenue
decreases revenue
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Monopoly
answer
Monopoly is a firm that is the sole seller of a product without close substitutes
question
Characteristics of a Monopoly.
answer
-market power,
-a "price-maker," not a "price-taker"
-high barrier to entry
-a "price-maker," not a "price-taker"
-high barrier to entry
question
Types of Barriers to Entry
answer
-owns a key resource
-The government gives a single firm exclusive right's
-Natural Monopoly
-The government gives a single firm exclusive right's
-Natural Monopoly
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Natural Monopoly:
answer
a single firm can produce the entire market Quantity at lower cost than 2 or more firms could
question
Solving for Price and Quantity and Profit on a Monopoly Graph.
answer
Q does not depend on P; rather Q and P are jointly determined by MC, MR, and the demand curve.
There is NO supply curve for monopoly
There is NO supply curve for monopoly
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What is a competitive market's demand curve?
answer
the market demand curve slopes downward,
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What is a competitive firm's demand curve?
answer
the demand curve for any individual firm's product is horizontal at the market price. The firm can increase Q without lowering P, so MR=P for the competitive firm.
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A monopolist is
answer
the only seller, so it faces the market demand curve. To sell a larger Q, the firm must reduce P, so MR ≠ P.
question
Why do Monopolies have a Deadweight Loss?
answer
-Because a monopoly charges a price above marginal cost, not all consumers who value the good at more than its cost buy it.
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What is Price Discrimination? What is it based on and why firms use it?
answer
-Selling the same good at different prices to different buyers.
-Based on WTP: a firm can increase profit by charging a higher price to buyers with higher WTP
-Examples: movie tickets, airline prices, discount coupons, need-based financial aid, quantity discounts
-Based on WTP: a firm can increase profit by charging a higher price to buyers with higher WTP
-Examples: movie tickets, airline prices, discount coupons, need-based financial aid, quantity discounts
question
What is Perfect Price Discrimination? Why is Perfect Price Discrimination not feasible in the real world?
answer
a situation in which the monopolist knows exactly each customer's willingness to pay and can charge each customer a different price.
It isn't possible because firms can't know the every buyers WTP
It isn't possible because firms can't know the every buyers WTP
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What can we do about Monopolies?
answer
A pure monopoly is rare, but many firms have market power, due to selling a unique variety of a product and having a large market share and few significant competitors.
question
Oligopoly
answer
only a few sellers offer similar or identical items
question
Monopolistic Competition
answer
-many firms sell similar but not identical products
-each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers.
-each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers.
question
Characteristics of Monopolistic Competition
answer
-Many Sellers
-Zero long run profit
-Free entry and exit
-product differentiation
-Has market power
- D curve down-sloping
-many substitutes
-Zero long run profit
-Free entry and exit
-product differentiation
-Has market power
- D curve down-sloping
-many substitutes
question
Characteristics of Monopoly's
answer
-one seller
-no free entry/ exit
-positive long run econ. profits
-has market power
-downward sloping D curve
-no close substitiutes
-no free entry/ exit
-positive long run econ. profits
-has market power
-downward sloping D curve
-no close substitiutes
question
Characteristics of Perfect Competition
answer
-many sellers
-free entry/ exit
-Zero long run econ profit
-firms sell identical products
-no market power
-price taker
- D curve horizontal
-free entry/ exit
-Zero long run econ profit
-firms sell identical products
-no market power
-price taker
- D curve horizontal
question
Monopolistic Competition in the Short Run
answer
-to maximize profit the firm produces Q where MR=MC
-used D curve to set P
-used D curve to set P
question
Monopolistic Competition in the Long Run
(entry and exit)
(entry and exit)
answer
entry and exit occurs until P=ATC and profit equals zero
question
Why does a Monopolistically Comp. Firm's Economic Profit go to 0 in the Long Run?
answer
A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase.
question
Excess Capacity
answer
the monopolistic competitor operates on the downward- slopingpart of its ATC curve, produces less than the cost-minimizing output; under perfect competition, firms produce the quantity that minimizes ATC.
question
Markup over marginal cost
answer
under monopolistic competition, P > MC; under perfect competition, P = MC.
question
Pros of Advertising
answer
-it provides useful info to buyers
-Informed buyers can more easily find and exploit price differences
-Advertising promotes competition and reduces market power
-Informed buyers can more easily find and exploit price differences
-Advertising promotes competition and reduces market power
question
Cons of Advertising
answer
-it's a waste of society's resources
- manipulates people's tastes
-Advertising impedes competition—it creates the perception that products are more differentiated than they really are, allowing higher markups
- manipulates people's tastes
-Advertising impedes competition—it creates the perception that products are more differentiated than they really are, allowing higher markups
question
Brand Name Pro's
answer
-Brand names provide information about quality to consumers
-Companies with brand names have incentive to maintain quality, to protect the reputation of their brand names
-Companies with brand names have incentive to maintain quality, to protect the reputation of their brand names
question
Brand Name Con's
answer
-Brand names cause consumers to perceive differences that do not really exist
-Consumers' willingness to pay more for brand names is irrational, fostered by advertising.
-Eliminating government protection of trademarks would reduce influence of brand names, and result in lower prices.
-Consumers' willingness to pay more for brand names is irrational, fostered by advertising.
-Eliminating government protection of trademarks would reduce influence of brand names, and result in lower prices.
question
Characteristics of Oligopolies
answer
-A market structure in which only a few sellers offer similar or identical products
-Strategic behavior in oligopoly: A firm's decisions about P or Q can affect other firms and cause them to react. The firm will consider these reactions when making decisions.
-Strategic behavior in oligopoly: A firm's decisions about P or Q can affect other firms and cause them to react. The firm will consider these reactions when making decisions.
question
Cartels
answer
-A group of firms acting in unison
-Both firms would be better off it both stick to the cartel agreement
-they supply the market as a monopoly would
-Both firms would be better off it both stick to the cartel agreement
-they supply the market as a monopoly would
question
Why do cartels break apart?
answer
each firm usually has incentive to cheat on the agreement
question
What is Nash Equilibrium?
answer
A situation in which economic participants interacting with one another each choose their best strategy given the strategies that all the others have chosen
question
What is a Prisoner's dilemma type game?
answer
A "game" between two captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial
question
What is a Dominant Strategy?
answer
A strategy that is best for a player in a game regardless of the strategies chosen by the other players.
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