Econ Exam #2 Professor Watson Olivet Nazarene University

What are the assumptions of perfect competition?

The demand curve is horizontal (The demand curve is the marginal revenue curve)

Price=Average cost

Homogenous products (Perfect substitutes)

Many buyers and sellers (Nobody has market power)

Full knowledge and complete information

Costless mobility of resources (Geography does not matter)

D=MR=P

What happens to entrepreneurs under perfect competition?

They do not exist.

What happens to change and adaptation under perfect competition?

No change or adaptation.

What happens to profits under perfect competition?

No profit/Normal profit.

(Profit is the result of uncertainty. No uncertainty=No profit)

Where does the Marginal Cost curve intersect with the Average Cost curve?

At the minimum point of the average cost curve.

Private cost

A cost paid by the consumer or the producer.

External cost

A cost paid by a third party.

Third party

A person external to the exchange.

Social cost

The cost to everyone.

(Private cost + External cost)

Externalities

External costs or external benefits on third parties.

Positive externality

External benefits.

(Underconsumption)

Negative externality

External costs.

(Overproduction)

Efficient equilibrium

The price and quantity that maximizes social surplus.

(Efficient Q+P)

External benefit

Consumption results in benefits beyond the consumer and producer.

Pigouvian tax

Tax on a good or service with external costs.

(Tax on negative externality)

Pigouvian subsidy

Tax on a good or service with external benefits.

(Subsidy for a positive externality)

Coase theorem

If transaction costs are low and property rights are clearly defined, private bargaining will ensure that markets equilibrate and are efficient even when externalities exist.

(Private property solutions. Usually best solution)

What does internalizing the externality do?

Decision makers have the incentive to account for all costs and benefits (all externalities).

Why aren't all costs taken into account?

Transaction costs and poorly defined property rights.

(Government policy should be focused on reducing transaction costs and defining property rights)

Moral hazard

Socialize the costs and privatize the benefits

Excludable

People can be prevented from using the good.

(Paying for a good)

Nonexcludable

People can't be prevented from using the good.

(The good is free)

Rival

One person's use of the good prevents another person's use of the good.

(Only one person can use the good at once)

Non-rival

One person's use of the good does not prevent another person's use of the good.

(Multiple people can use the good at once)

Private good

Excludable and rival

(Snickers bar)

Public good

Nonexludable and non-rival

(The radio)

Club good

Exludable and non-rival

(Apple music)

Common resources

Nonexcludable and rival

(Fish)

Tragedy of the commmons

Overuse of a resource leads to destruction. Due to nobody owning the resource.

(Negative externality)

What are costs in the long run?

All costs are variable.

(VC)

What are costs in the short run?

Variable and fixed costs.

(VC + FC)

Explicit cost

A cost that requires a money outlay (expenditure).

Implicit cost

A cost that does not require a money outlay (expenditure).

(Differences between job choices)

Economic profit

Total revenue minus total costs including implicit costs.

Accounting profit

Total revenue minus explicit costs.

Fixed costs

Costs that do not vary with output.

(New factory)

Variable costs

Costs that do vary with output.

(Cost of goods sold)

Total cost equation

TC=FC+VC

Marginal revenue (MR)

The change in total revenue from selling an additional unit.

(Change in TR)/(Change in quanitity)

Marginal cost (MC)

The change in total costs from producing an additional unit.

(Change in TC)/(Change in quantity)

Total revenue equation

TR=P*Q

Average total cost equation

ATC=TC/Q

If MR>MC, what should the firm do?

Produce more.

If MR=MC, what should the firm do?

Stop producing.

If MR

Produce less.

Average variable cost formula

AVC=(Change in VC)/(Change in Q)

Average fixed cost formula

AFC=FC/(Change in Q)

(Decreases over time)

What happens when Price=Average costs?

Break-even point.

Increasing cost industry

An industry where costs increase with greater output.

(Upward sloping supply curve)

Constant cost industry

An industry where costs don't change with greater output.

(Horizontal/Elastic supply curve)

Decreasing cost industry

An industry where costs decrease with greater output.

(Downward sloping supply curve)

Monopoly power

A firm with market power.

(Firm has the ability to raise the price above MC without fear of entry from other firms)

What are the two possible reasons for a markup?

Evidence of monopoly pricing or price searching.

Reasons for monopoly

Patents

Natural monopoly

Natural monopoly

When a single firm can supply the entire market at a lower cost than two or more firms.

Regulatory capture

Firms have control over the agencies that regulate them.

(Duke energy).

Cartel

A group of suppliers who try to act as if they are a monopoly.

Oligopoly

A market that is dominated by a small number of firms.

(Smartphone market)

What are the three main reasons that cartels break down?

Cheating, entry of other competitors, or government regulation.

Monopolistic competition

A market with a large number of firms selling similar, but not identical products.

(Grocery stores)

What happens to the demand curve under monopolistic competition when moving from the short run to the long run?

The demand curve will shift to the left and become more elastic.

Monopolistic competition characteristics

Greater variety of products, geography matters, incomplete information, asymmetric information, and transportation costs matter, i.e., perfect competition assumptions do not hold. (Ex. Phones, Cars)

Competition over quality etc.

Advertising matters

-Informative

-Change tastes

-Signaling

Price discrimination

Selling the same goods or services to different customers at different prices.

What needs to exist in order for firms to engage in price discrimination?

No resentment, no arbitrage (buy low, sell high), the ability to identify the different demand curves for the different types of customers.

1st degree price discrimination

Each customer is charged their maximum willingness to pay.

(AKA Perfect price discrimination)

2nd degree price discrimination

Price based on quantity.

(The more you buy the less you pay)

3rd degree price discrimination

Price based on differences in the category of consumer.

(Movie theater tickets)

Tying

Must use a second good with a first good, which is only supplied by the firm.

(Printer and ink for that printer)

Bundling

Buying goods together as a bundle.

Marginal Product of Labor (MPL)

The increase in revenue created by hiring an additional unit of labor.

(AKA Marginal Revenue Product of Labor (MRPL))

Reservation wage

Minimum wage that labor accepts to work.

What happens when W>MPL?

Unemployment, wages will decrease.

What happens when W=MPL?

Equilibrium.

What happens when W

Shortage, wages will increase.

Human capital

Tools of the mind that increase Marginal Product of Labor

Compensating differential

A difference in wages that offsets differences in working conditions.

(Riskier jobs=Higher pay)

What happens when prices are above the average cost?

Profit.

What happens when prices are below the average cost?

Loss.

Alternative Profit equation

π=(P-AC)Q

Is advertising important in monopolistic competition?

Yes.

Is innovation short run or long run under monopolistic competition?

Short run.

Is mimicry short run or long run under monopolistic competition?

Long run.

(Lower profits)

Free Rider

Enjoys the benefits without the costs

Forced Rider

No benefits, but pays the costs

Statistical Discrimination

Using information about group averages to make conclusions about individuals

Public Choice

The study of political behavior using the tools of economics

Median Voter Theorem

When voters vote for the policy that is closest to their ideal point on a line, then the ideal point of the median voter will beat only other policies in a majority rule election