Econ Exam 2

Firm Profit

π = TR-TC

π=Q(P-ATC)

Accounting Costs

Explicit costs - Visible (Electric bills, wages, rent, advertising)

Opportunity Costs

Implicit costs - Invisible (Time that could’ve been spent elsewhere, Capital invested in business, Labor of owner who doesn’t get paid)

Accounting Profit

Total Revenue - Explicit Costs

Economic Profit

Total Revenue - Total Cost (Explict & Implicit)

Fixed Cost

Cost paid once to start production (Ex: garbage truck and garbage factory)

Variable Cost

Cost that varies with output (Ex: wages and gas)

Marginal Product

∆ Total productivity / ∆ workers

Average Product

total productivity / # of workers

Diminishing Marginal Product

As we increase the amount of output, it becomes more costly to do so (single kind of input)

Total Cost Formula (TC)

TFC + TVC

Average Fixed Cost Formula (AFC)

TFC / Q

Average Variable Cost Formula (AVC)

TVC / Q

Average Total Cost Formula (ATC)

TC / Q

Marginal Cost Formula (MC)

∆ TC / ∆ Q

MC on a Graph

Check mark shape

ATC on graph

Parabola with minimum on MC curve

AVC on graph

Parabola with minimum on MC curve

MC < ATC

ATC falls

MC > ATC

ATC rises

Production Function

Q = f(K,L)

Total Cost of Production

Cost of K + Cost of L

Long Run

A timeframe where fixed costs become variable costs

Long Run Average Total Cost (LRATC)

Shows scale and cost of providing additional output

Economies of Scale

When a firm decreases average cost by scaling up all production equally (increasing returns to scale)

Diseconomies of Scale

When a firm increases LRATC by scaling up all production equally (decreasing returns to scale)

Perfectly Competitive Markets

1) Similar goods

2) Many buyers and sellers

3) Free entry & exit of firms

4) Firms are price takers (no control over price)

Examples of Perfectly Competitive Markets

Gas and Produce

Profit Maximizing

MR = MC

AVC < p < ATC

Opperate in short run, Exit in long run

Sunk Cost

A cost that has been paid as a result of past decisions (Ex: In SR, fixed costs are sunk costs)

Sunk Cost Fallacy

When an agent makes a different decision with a sunk cost than without the sunk cost

Positive Profits Lead to:

Positive profits → Firms would enter → More competition → Decrease in price → π decreases

Negative Profits Lead to:

Negative profits → Firms would exit → Less competition → Increase in price → π increases

Economically Efficient

Firms produce at the minimum of LRATC (Ex: Perfect Competition in the LR)

Non-example of Economic Efficiency

Using pennies and nickels as currency

Monopoly Characteristics

1) Many buyers but exactly one seller

2) A unique product with no good substitutes

3) Products in market with high barriers to entry

Examples of Monopolies

Electric companies, Patents, DeBeers (Diamond company)

Causes of Monopolies

1) Natural Monopoly

2) Resource Controlled Monopoly

3) Government Created Monopoly

Natural Monopolies

• A single firm that has lower costs than any potential competitor

• A firm existing in a market makes entry for other firms more difficult

• Caused by high fixed costs and low marginal costs

• Impacted by economies of scale → one firm controlling the whole network of power lines is less costly than multiple firms having control

Examples of Natural Monopolies

Power lines, Water irrigation

Resource Controlled Monopolies

It is difficult to compete with a monopoly that has so much capital invested

Examples of Resource Controlled Monopolies

1) In early 1900’s ALOCA owned 90% of world’s bauxite (used to make aluminum)

2) DeBeers owned about 70% of world’s Diamond mines until early 2000’s

Government Created Monopolies

Patentes and Copyright laws can create monopolies

Example of Government Created Monopolies

Government preventing competition on post office/first class mail

Incentive: Ensures anyone can send mail in the U.S.

Pure Monopoly (one firm)

Price Setters

Perfect Competition (many firms)

Price Takers

Price Effect

Loss in TR from decrease in price

Output Effect

Increase in TR from increase in Q

Marginal Revenue for a Monopolist

MR must be under the D curve

MR = price effect + output effect

π Max for a Monopolist

MR = MC for Q_m , go to demand curve for p_m

No long run or short run in monopolies

Defects of Monopolies

1) Reducing Competition limits options available to consumers

2) Consumers are less able to direct producers to serve their interests

3) Prices are higher and output is lower

4) Rent-seeking

Rent-Seeking

The act of wasting resources in an effort to obtain market power or manipulate public policy

Examples of Rent-Seeking

Political campaigns, firms lobbying politicians

Example for Prices being higher and output being lower (Graph)

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How to Deal with Monopolies

1) Restructure (AT&T was disolved)

• Prevent Mergers

2) Reduce trade barriers

3) Price Controls (price ceiling of $35 on insulin for people on medicare)

4) Do nothing

Antitrust Policy

Regulations aimed at preventing firms from gaining too much market power

Price Discrimination

Selling a given product at more than one price to different consumers

First Degree Price Discrimination

Firms can charge all consumers a different price

• No consumer surplus

Ex: College Tuition

Second Degree Price Discrimination

Firms charge a different price based on quantity

Ex: Bulk buying, Coupons

Third Degree Price Discrimination

Firms charge a different price based on groups of consumers

Ex: Student tickets, Military, Senior, Adult, Children

Monopolist Competition

Perfect competition with differentiated products

• Many firms

• Free entry/exit

• Differentiated products

Most Industries

Monopolist competition or Oligopoly

Benchmarks

Perfect competition or Pure monopoly

Examples of Monopolist Competition

Fast Food, Clothing

Oligopoly

Few sellers with different products and barriers to entry/exit

Examples of Oligopolies

Airlines, Phone Companies, Compuyers, Soda

Game Theory

Economic Study of how agents interact in strategic situations

A Game Consist of

1) Players

2) Strategies

3) Payoffs

Extensive (Tree) Form

A sequential game (players move one after another)

Backward Induction

Starting at the last player nodes in the tree, denote what decision that player would make to maximize their profit and repeat

Backward Induction Contains

Strategies not Payoffs

Matrix/Strategic Form

A game where players choose their strategies simultaneously

Dominant Strategy

A Strategy for a player that yeilds they highest payoff regardless of what the other player does

Nash Equilibrium (Stable Point)

A strategy for each player such that, given what others are doing a player can’t deviate and do better

Nash Equilibrium must Include

Dominant strategy

Mixed Strategies

Where different pure strategies are selected with probabilites set by the players

Oligopoly is a:

Prisoners Dilemma

Examples of Prisoner’s Dilemmas

Standing at concerts, Shouting at parties, holding the door

Tit-for-Tat

First play of the game cooperate. In any subsequent play, play the startegy that the other player played in the previous round