Economics 1 (Sem 2)

production function

the relationship that describes how inputs like capital and labour are transformed into output.

First welfare theorem - general equilibrium

In a pure exchange economy with only two consumers and two goods, for any given initial allocation of the two goods, a competitive exchange process will always exhaust all possible mutually beneficial gains from trade.

Second welfare theorem - general equilibrium

If consumers have convex indifference curves, any efficient allocation can be sustained as a competitive equilibrium.

When do we see a backward bending labour supply curve?

When the income effect dominates over the substitution effect over some range of wage rates.

What does a firms demand for capital equipment depend on?

Rate of interest, purchase price of capital and rates of technological and physical depreciation.

In the loanable funds market …

the demand curve is downward sloping because lower interest rates make more projects profitable

Why are bond prices and interest rates inversely related?

When interest rates rise, new bonds are issued with higher yields, making existing bonds with lower yields less attractive.

Peak-load pricing

A strategy where prices for goods or services are higher during periods of high demand (peak periods) and lower during periods of low demand (off-peak periods)

How is the optimal degree of product variety related to population density?

A greater population density can sustain more product variety ceteris paribus. So England likely has greater product variety than Scotland, and both places probably come ahead of Tibet but behind Hong Kong.

At what output is average cost minimised for a perfectly competitive firm?

When ATC = MC or when the first derivative of the ATC curve = 0

What is the trade-off between cost and variety?

The extra utility that consumers get from product variety must be weighed against the higher prices that result from product differentiation and monopolistic competition. Greater variety is obtained at higher costs.

Why do firms offer price matches?

Firms often offer a “find this deal somewhere else for cheaper and we will match this price plus 10%” as a threat of tit-for-tat

Can the leader ever get a lower profit in a Stackelberg equilibrium than he would get
in the Cournot equilibrium?

No, because one of the choices open to the Stackelberg leader is to choose the level of output it would have in the Cournot equilibrium. So it always has to be able to do at least this well.

Do oligopolies produce an efficient level of output?

In general, no. Only in the case of the Bertrand model does P = MC.

What happens when government imposes a quantity tax on a monopolist?

For a linear demand curve, the general rule is that when a monopolist faces a quantity tax, the monopolist will raise the price by half the amount of the tax.

negative externality

if an activity imposes costs on others or creates benefits for others that are not captured in private costs and benefits

What does it mean for a good to be non-diminishing?

Any one person’s consumption of a good has no effect on the amount of it available for others.

What does it mean for a good to be non-excludable?

It is either impossible or prohibitively costly to exclude people from consuming the good.

private good

a good that has a high degree of diminishability and excludability

pure public good

A good that has a high degree of non-diminishability and non-excludability

collective good

A good that is excludable and has a high degree only of non-diminishability

impure public good

A good that has some non-diminishability and non-excludability

free riding

choosing not to donate to a cause but still benefiting from the donations of others

median voter

the voter whose ideal outcomes lies above the ideal outcomes of half the voters

single-peakedness

preferences that exhibit a single most-preferred outcome, with other outcomes ranked lower as their distances from their most-preferred outcome increases

Coase Theorem

When the parties affected by externalities can negotiate costlessly with each other, an efficient outcome results no matter how the law assigns responsibility for damages.

In general equilibrium, can there be excess demand for every good?

No. By Walras’ Law, if there is a surplus of one good, there is a shortage of some other good.

positive externality

if an activity imposes costs on others or creates benefits for others that are not captured in private costs and benefits

social benefit and cost

the combined monetary amount people would be willing to pay for activity x and the combined cost of activity x

private benefit and cost of activity x

the maximum monetary amount a person would be willing to pay to do activity x and the cost to that person of doing activity x

What do economists mean when they say that short-run competitive equilibrium is efficient?

t means that the total surplus, i.e. consumer and producer surplus combined, is maximised. They mean if it is efficient then resources are being exploited as best as possible. That results in allocative efficiency, which means there is no potential for mutual gain through further exchange. It also means that the total surplus, consumer and producer surplus combined, is maximized. It does not, however, mean that producer surplus is maximized because a firm with the power to set price will increase producer surplus at the expense of consumer surplus and allocative efficiency.

Under what conditions would firms likely act as price takers even though there are only a few of them in the industry?

Firms are likely to act as price takers even if there are only a few firms in the industry if it is relatively easy to enter the market i.e. if the current firms were to charge too much more firms would enter the market. Although they can vary their prices, they largely act as price takers.

What is the difference between economic and account profit?

Economic profit takes into account both explicit and implicit costs (e.g. opportunity costs) whereas accounting profit only accounts for explicit costs.

Peak-load pricing is

designed to move consumers up along their demand curve.

general equilibrium analysis

the study of how conditions in each market in a set of related markets affect equilibrium outcomes in other markets in that set

Edgeworth exchange box

a diagram used to analyse the general equilibrium of an exchange economy

If the marginal rate of substitution between future and current consumption is less than one for a consumer, then …

the consumer exhibits a negative time preference

The quantity of loanable funds supplied by a firm is …

positively related to the interest rate

Why do higher real interest rates make future events economically less important?

Higher interest rates reduce the present value of any given nominal income stream

What is the practical problems with using MP rather than AP to determine whether to hire another worker?

It is often difficult to determine what individual input a worker adds to the production system but average product of labour is often easier to determine and often correlated (however, it can be costly to use AP as though it is MP).

What is the definition of long run in production?

When all inputs can be changed/are variable compared to in the short-run when at least on variable is fixed (usually capital, K).

Pareto superior

an allocation that at least one individual prefers and others like at least as well

marginal rate of transformation (MRT)

the rate at which one output can be exchanged for another at a point along the production possibilities frontier

production possibilities frontier

the set of all possible output combinations that can be produced with a given endowment of factor inputs

Contract curve

a curve along which all final, voluntary contracts must lie

Pareto optimal

the term used to describe situations in which it is impossible to make one person better off without making at least some others worse off

What option do unionised workers have?

They can bargain collectively over the terms and conditions of employment

real capital

product equipment that generates a flow services; also called physical capital

physical capital

productive equipment that generates a flow of services; also called real capital

financial capital

money or some other paper asset that functions like money

present value

the present value of a payment of X euros T years from now is X/(1+r)^T where r is the annual rate of interest

marginal rate of time preference (MRTP)

the number of units of consumption in the future a consumer would exchange for 1 unit of consumption in the present

permanent income

the present value of lifetime income

technological obsolescence

the process by which a good loses value not because of physical depreciation, but because improvements in technology make substitute products more attractive

perpetual bond or consol

a bond that pays a fixed payment each year in perpetuity; also called a consol

risk premium

a payment differential necessary to compensate the supplier of a good or service for having to bear risk

economic rent

the difference between what a factor of production is paid and the minimum amount necessary to induce it to remain in its current use

Statistical discrimination

is the result, not the cause, of average productivity differences between groups. Its sole effect is to reduce wage variation within each group

Employer discrimination

wage differentials that arise from an arbitrary preference by the employer for one group of worker over another

Customer discrimination

the firm’s customers do not wish to deal with minority employees

What option do non-unionised workers have?

The firm simply announces its offer and the workers can either accept or reject, by staying with or leaving the firm

Compensating wage differentials

where unpleasant jobs are paid at a premium to compensate for the unpleasantness

marginal factor cost (MFC)

the amount by which total factor cost changes with the employment of an additional unit of input

total factor cost (TFC)

the product of the employment level of an input and its average factor cost

average factor cost (AFC)

another name for the supply curve for an input

Value of marginal product (VMP)

the value, at current market price, of the extra output produced by an additional unit of input

optimality condition for a monopolist

a monopolist maximises profit by choosing the level output where marginal revenue equals marginal cost

reaction function

a curve that tells the profit-maximising level of output for one oligopolist for each amount supplied by another

Bertrand model

oligopoly model in which each firm assumes that rivals will continue charging their current prices

Cournot model

oligopoly model in which each firm assumes that rivals will continue producing at their current output levels.

X-inefficiency

a condition in which a firm fails to obtain maximum output from a given combination of inputs

Economic profit

Difference between total revenue and total cost, taking account of explicit and opportunity costs.

shutdown condition

if price falls below the minimum of average variable cost, the firm should shut down in the short run.

pecuniary diseconomy

a rise in production cost that occurs when an expansion of industry output causes a rise in the prices of inputs.

price elasticity of supply

the percentage change in quantity supplied that occurs in response to a 1 per cent change in product price

allocative efficiency

a condition in which all possible gains from exchange are realised

pareto efficient

an outcome where it is not possible to make some person better off without harming another person

Marginal revenue

the change in total revenue that occurs as a result of a 1-unit change in sales

Normal profit

the opportunity cost of resources owned by the firm

Marginal revenue

the change in total revenue that occurs as a result of a 1-unit change in sales

Average variable cost (AVC)

variable cost divided by the quantity of output

output expansion path

the locus of tangencies (minimum-cost input combinations) traced out by an isocost line of given slope as it shifts outwards into the isoquant map for a production process.

natural monopolies

industries whose market output is produced at the lowest cost when production is concentrated in the hands of a single firm

isocost line

a set of input bundles each of which costs the same amount

Marginal cost (MC)

Change in total cost that results from a one-unit change in output

long run

the shortest period of time required to later the amounts of all inputs used in a production process

short run

the longest period of time during which at least one of the inputs used in a production process cannot be varied

variable input

an input that can be varied in the short run

fixed input

an input that cannot vary in the short run

law of diminishing returns

if other inputs are fixed, the increase in output from an increase in the variable input must eventually decline.

total product curve

a curve showing the amount of output as a function of the amount of variable input.

marginal product

change in total product due to a unit change in the variable input

average product

total output divided by the quantity of the variable input

isoquants

the set of all input combinations that yield a given level of output

marginal rate of technical substitution (MRTS)

the rate at which one input can be exchanged for another without altering the total level of output.

increasing returns to scale

the property of a production process whereby a proportional increase in every input yields a more than proportional increase in output.

constant returns to scale

the property of a production process whereby a proportional increase in every input yields an equal proportional increase in output.

decreasing returns to scale

the property of a production process whereby a proportional increase in every input yields a less than proportional increase in output.