Microeconomics Quiz Chapter 7-8

Firm

A business entity that transforms inputs into outputs and then offers it for sale.

Entrepreneur

Risk-Taker who brings inputs together, makes economic decisions, and offers products for sale.

2 types of Firms

Sales Proprietor/Partnership + Corporation

Sale Proprietor/Partnership

-Most basic; owner overseas daily operations; relatively easy to establish; limited ability to raise financial capital (Loans from bank)

- Most locally owned, small businesses (restaurants, salons, mechanics, etc…)

-70% of firms are in this category

Corporation

-National, multi-national business

-Ability to raise a lot of financial capital (Bonds, IPOs, private equity)

-90% of all goods are sold by corporations

Accounting Profit

= T.R.-Explicit Costs

Explicit Costs

Expenses paid directly to someone else

-Ex: Wages, utilities, vendor, payments, etc…

Economic Profit

=T.R-Explicit Costs-Implicit Costs

Implicit Costs

The opportunity cost of using resources

-Ex: Salary the owner could have earned working somewhere else

-Ex: Rent the owner could have earned instead of using building

Positive Econ. Profit

-Owner is financially better off in current business, compared to next best alternative

1. Zero Econ. Profit

-Owner is financially indifferent between current business and best next alternative

1. Negative Econ. Profit

-Owner is financially worse off in current business compared to the next best alternative

Normal Rate Of Return

is the return just sufficient to keep investors satisfied; it therefore represents the opportunity cost of capital

Short Run

At least one input is fixed; typically plant capacity (Long term lease)

Long Run

All of your inputs can change

Short-Run Production

-Plant capacity is fixed, but labor can change

Marginal Product (MP)

The additional output created when we hire one more worker

-MP=(Change in Q/Change in L)

Increasing Returns

The additional worker adds more to total output than the previous worker

-Specialization of Labor

Diminishing Returns

The additional worker adds less to the total output than the previous worker

-Fixed space limits productivity gains

Fixed Costs (FC)

Costs that do not vary with output exist even when output is zero

Variable Costs(VC)

Cost that fluctuates as output changes

Total Cost (TC)

FC+VC

Formulas

AFC=FC/Q 

AVC=VC/Q

ATC=TC/Q or (AFC+AVC)

Marginal Cost (MC)

The additional cost of producing one more unit of output

 -MC= Change in Total Cost/ Change in Quantity

Long Run Average Total Cost:(LRATC)

-The lowest possible per-unit cost of production that a business can achieve

Economies of Scale

As production increases, per-unit costs decrease

-Specialization, Vendor Contracts

Constant Returns to Scale

As production increases per-unit costs remain unchanged

Diseconomics of Scale

As production increases, per unit costs increase

-Inefficiency with large-scale operations

Economies of Scope:

A firm lowers costs by producing inter-related goods

-Ex: Appliances

1. Perfect Competition ((Worst for Seller but Best for buyer) Most efficient)

-Highly competitive market (Many, many sellers!)

-Easy for new firms to join industry; no barriers to entry

-All sellers are offering and identical product

-Seller has no control over the price of the product 

-Seller earns zero econ profit in the long run

-Ex: Potato, Oil

1. Monopolistic Competition ((Most Common) Better for sellers)

-Higly Competitive market (Many sellers!)

  -Easy for firms to join; no barriers

 -Sellers offer differentiated products

 -Some control over price

 -Seller earns zero econ profit in the long run

    -Ex: Pizza

Oligopoly ((Most Common) Better For sellers)

-Only a few firms in the entire industry

-Significant barriers to entry

-More control over price; mutual

-Interdependence

-Potential for positive econ profit in the long run

-Ex: Airline

1. Monopoly (Best for seller but worst for buyer)

-Only one firm in the industry

-Extreme barriers to entry; impossible to join

-Control over price; no competitive pressure

-Potential for positive econ profit in the long run

-Ex: Patented drug from a pharmaceutical co; utilities

Price Taker

Price is set by industry wide forces of supply and demand, not by the individual seller.

So in Perfect Competition

the seller does not choose the price, but they must choose the quantity

Marginal Revenue (MR)

The additional revenue generated from selling one more unit of a good

      MR= CHANGE in TR/ CHANGE in Q                    (TR=PxQ)

MC> MR,

the additional costs exceed the additional revenue; business should scale back and reduce Qty

-Ex: 5th oz brings in $1,000 in extra revenue, but costs an extra $1,500 to mine

MR>MC,

the extra profit exceeds the extra cost; Don't stop here keep producing to earn more profit

-Ex: The 2nd ox brings in $1,000, and only costs an extra $400 to mine

Calculating Profit or loss in the Short-Run

Profit=TR-TC

=(PxQ)-(ATCxQ)

Quick Guide

If P>ATC, Positive Econ Profit

If P< ATC, Negative Econ Profit

If P=ATC Zero Econ Profit

Econ.Losses: Short Run Decision

-In the short run, firms must pay fixed costs, regardless of output decisions

Shut down if P<AVC

1. Option 1: Shut down and only pay fixed costs

-Earns $0 revenue, but pays $0 in variable costs

Continue Operating if P>AVC

1. Option 2: Continue Operating in the short run 

-Earnes revenue, but pays both fixed and variable costs

If firms are earning losses in the short run…

-Firms exit the industry 

-Industry supply decreases, Price increases

-Continues until firms no longer have incentive to leave industry

-Zero Econ. Profit

1. If Firms are earning profits in the Short Run…

-New firms join the industry 

-Industry Supply increases, Price decreases

-Continues until new firms no longer have an incentive to join

-Zero Econ Profit

Productive Efficiency:

Produced at lowest cost (LRATCmin)

-Best for Buyers

-Worst for sellers

-Allocative Efficiency

 P=MC

NORMAL PROFIT

A normal profit is equal to zero economic profit,
where P =ATC.