Microeconomics Final

explicit costs

a cost that requires an outlay of money (cost of books)

implicit costs

does not require an outlay of money; it is measured by the value, in dollar terms, of benefits that are forgone (wages forgone because of being a full-time student)

accounting profit

revenue - explicit cost

economic profit

revenue - explicit cost - implicit cost

capital

total value of assets owned by an individual or firm - physical assets plus financial assets

principle of either-or-decision making

when faced with an either-or choice between two or more activities (all else equal), choose the one with the positive economic profit

marginal cost

the additional cost incurred by producing one more unit of that good or service

mc = mr

a firm will maximize its profit (or minimize its loss) it it produces to the ouput level if the marginal revenue is equal to the marginal cost

increasing marginal cost

each additional unit costs more to produce than the previous one

constant marginal cost

Each additional unit costs the same to produce as the previous one.

decreasing marginal cost

Each additional unit costs less to produce than the previous one.

marginal benefit

the additional benefit derived from producing one more unit of a good or service

decreasing marginal benefit

activity when each additional unit of the activity yields less benefit than the previous unit

sunk costs

a cost that has already been incurred and is not recoverable

three reasons people might rationally choose a worse payoff

concerns about fairness, bounded rationality, risk aversion

six common mistakes of decision making

1. misperceptions of opportunity costs,

2. overconfidence

3. unrealistic expectations about future behavior

4. counting dollars unequally

5. lose aversion

6. status quo bias: tendency to avoid making decision altogether

production

process of turning inputs into outputs

production function

relationship between the quantity of inputs a firm uses and the quantity of output it produces

fixed input

an input whose quantity is fixed for a period and cannot be varied

variable input

an input whose quantity the firm can vary at any time

inputs in the long run

can be varied

inputs in the short run

at least one input is fixed

total product curve

shows how the quantity of output depends on the quantity of the variable input for a given quantity of the fixed input

marginal product

initially rises as more workers are hires, then it declines

MPL

change in quantity of output produced by one additional unit of labor

diminishing returns

when an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input.

the MPL

defined as the increase in the quantity of output w when you increase the quantity of that input by one unit

fixed cost

cost that does not depend on the quantity of output produced. it is the cost of the fixed production

variable cost

cost that depends on the quantity of output produced. it is the cost of the variable input

total cost formula

TC = FC + VC

marginal cost

the change in total cost generated by one additional unit of output.

marginal cost equation

MC = ΔTC/ΔQ where Δ = change, TC = total cost and Q =quantity of output

average cost

= total cost per unit of output produced; ATC = TC/Q

average fixed cost

fixed cost per unit of output produced; AFC = FC/Q

average variable cost

variable cost per unit of output produced; AVC = VC/Q

spreading effect

The larger the output, the more output over which fixed cost is spread, leading to lower average fixed cost.

diminishing returns effect

The larger the output, the more variable input required to produce additional units, which leads to higher average variable cost.

is marginal cost upward sloping?

yes because of diminishing returns

is average variable cost upward sloping?

yes but flatter than marginal cost

is average fixed cost downward sloping?

yes because if spreading effect

how do the marginal cost curve and average total cost curve below

marginal curve intersects average cost curve from below

minimum-cost output

quantity of output at which average total cost is lowest — the bottom of the u-shaped average total cost curve

at the minimum-cost output

average total cost is equal to the marginal cost

long-run average total cost curve

shows the relationship between output and average total cost fixed cost has been chosen to minimize average total cost for each level of output

when long-run average total cost declines as output increases

there are increasing returns to scale (economies of scale)

when long-run average total cost increases as output increases

there are decreasing returns to scale (diseconomies of scale)

there are constant returns to scale when long-run average total cost

s constant as output increases

market share

the fraction of the total industry output accounted for by that producer’s output

prefect competition key characteristics

1. market share

2. product is standardized across sellers

3. free entry and exit

total revenue

price times quantity

profit

total revenue - total cost

marginal revenue

change in total revenue generated by an additional unit of output; change in TR/ change in Q

optimal output rule

profit is maximized by producing the quantity og output at which the marginal revenue of the last unit is produced is equal to its marginal cost

If producing another unit adds more to revenue than cost, profit will increase.

true

if MR > MC (greater than)

producing more will add to profit.

MR < MC (less than)

producing less will add to profit.

profit-maximizing rule is

Choose the quantity of output where P = MC.

when is production profitable?

1. if TR > TC, the firm is profitable (greater than)

2. if TR = TC, the firm breaks even

3. if Tr < TC, the firm incurs a loss (less than)

firm will break even when

MR = MC,

fixed cost must be paid…

regardless of whether the firm produces in the short run

a firm will produce at every price above minimum ATC

where price intersects the MC curve…

firms will stop producing in the short run if

the market price falls below the shut-down price…

if P > break-even (min ATC)

firms are profitable

industry supply curve

shows the relationship between the price of a good and the total output of the industry as a whole.

short-run industry supply curve

hows how the quantity supplied by an industry depends on the market price given a fixed number of producers.

short-run market equilibrium

when the quantity supplied equals the quantity demanded, taking the number of producers as given.

because of entry and exit

1. a higher price attracts new entrants in the long run, raising industry output and lowering price

2. a fall in price induces existing producers to exit in the long run, reducing industry output and raising price

prefect competition

many firms, easy entry and exit, good substitutes, one market created price, no power and one price taker, no economic profit, local farming

monopolistic competition

many firms, easy entry and exit, substitutes but differentiated, advertising and promotion, product differentiation allows firm to control price, no economic profit, clothing and restaurants

oligopoly

few firms, difficult entry, substitutes homogenous/differentiated, game theory + firms are rivals, price markers, possible economic profit, autos + insurance + banks

monopoly

one firm, entry highly impossible, no good substitutes, from is the market, significant price makers, economic profit, utilities co. + new firms with copyright

barriers to entry include (monopoly)

1. control of natural resources other than inputs

2. increasing returns to scale

3. technological superiority

4. government-made barriers, including patents and copyrights

profit-maximizing rule

Profit is maximized at the Q where MR = MC.

quantity effect

one more unit is sold, increasing total revenue by the price at which the unit is sold

a price effect:

to sell the last unit, the monopolist must cut the market price on all units sold; this decreases total revenue

profit maximization

1. choosing a quantity

2. choosing a price

In order to find the profit-maximizing quantity of output for a monopolist,

you look for the point where the MR curve crosses the MC curve.

Monopolists don’t have supply curves

true

Monopoly profit comes at consumers’ expense:

When a monopoly raises prices and lowers Q, consumer surplus falls and deadweight loss is created.

solutions for natural monopolies

1. public (government) ownership

2. price regulation

monopsony

exists when there is only one buyer of a good.

price discrimination

firms charge different prices to different consumers for the same good.

perfect price discrimination

a firm will charge each custom era different price, the maximum price each is willing to pay.

3rd degree price discrimination

where the seller has the market power to split the costumer base according to a unique demographic (ex. students, seniors, early bird specials, happy hour)

2nd degree price discrimination

a situation where the consumers are charged difference price, different groups, based on how much they buy - quantity (ex. cotsco, kohls, cvs)

1st degree price discrimination

the seller has the market power to change (eBay)

barriers to entry oligopoly

1. control of natural resources or inputs

2. increasing returns to scale

3. technological superiority

4. government-made barriers

imperfect competition:

no one firm has a monopoly, but producers can affect market prices

Herfindahl–Hirschman Index, or HHI.

for an industry is the sum of the squares of each firm’s share of market sales.

HHI of less than 1,000

indicates a strongly competitive market.

HHI of 1,000 to 1,800

indicates a somewhat competitive market.

HHI above 1,800

indicates an oligopoly.

If HHI is above 1,000,

a merger that results in a significant increase in the HHI will receive special scrutiny and is likely to be disallowed.

duopoly

an oligopoly consisting of only two firms

cooperation

between firms may be profitable, but it is unstable—and illegal in the United States.

collusion

firms cooperating to raise each others’ profits

cartel

an agreement by several producers to restrict output in order to increase their joint profits.

Noncooperative behavior

firms ignoring the effects of their actions on each others’ profits

Game theory:

the study of behavior in situations of interdependence; a way of predicting outcomes in strategic situations like oligopolies

nash equilibrium:

a situation where all parties are behaving and doing the best they can (both confess)