Microeconomics: Trade, Firm Behavior, Market Structures, Externalities, and Public Choice

Comprehensive review flashcards covering microeconomic theory, including trade, firm cost curves, competitive equilibrium, monopoly, imperfect competition, externalities, public goods, and political economy.

Production Possibility Frontier (PPF)

A graphical representation showing the maximum combinations of two goods an economy or individual can produce given available resources and technology, demonstrating productive trade-offs and efficiency.

Slope of the Production Possibility Frontier

The measure of the opportunity cost of producing one good in terms of the other; for Robinson, the slope of $-3$ indicates that he must give up $3$ coconuts to catch $1$ additional fish.

Production Efficiency along the PPF

The condition achieved at all points along the production possibility frontier where an individual cannot increase the quantity produced of one good without reducing the quantity produced of the other.

Robinson's Production Possibilities Frontier (Figure 20a)

The linear production frontier showing Robinson's maximum potential output of $24$ coconuts or $8$ fish in an $8$-hour day, with point $A$ illustrating his initial consumption choice of $15$ coconuts and $3$ fish.

Absolute Advantage

The ability of an economic actor or nation to produce a greater absolute quantity of a good than competitors using the exact same amount of productive resources.

Crusoe's Production Possibilities Frontier (Figure 20b)

The production frontier showing Crusoe can collect up to $36$ coconuts or catch $36$ fish in an $8$-hour day, with a slope of $-1$ reflecting an opportunity cost of $1$ coconut per fish, and initial consumption at point $B$ of $18$ fish and $18$ coconuts.

Comparative Advantage

The ability of an individual or nation to produce a good at a lower opportunity cost—sacrificing less of an alternative good—than another producer.

Opportunity Cost in Determining Comparative Advantage

The amount of good $A$ that must be sacrificed to produce an additional unit of good $B$; the producer who gives up less of good $A$ possesses the comparative advantage in good $B$.

Gains from Trade

The expansion in total output and collective consumption realized when economic actors specialize in activities where they hold a comparative advantage and engage in exchange.

Extent of the Market and Specialization

The economic principle stating that larger and more extensive markets offer broader opportunities for specialization, leading to larger aggregate gains from trade.

Distributional Consequences of Free Trade

The uneven dispersion of costs and benefits across domestic groups as free trade shifts industry sizes, causing affected groups who experience losses to oppose trade liberalization.

Small Economy Assumption in International Trade

The analytical assumption that a domestic country is so small relative to the global market that its domestic supply and demand choices do not alter the prevailing world price ($P_W$).

Welfare Effects of Isolation and Free Trade for an Exporter (Figure 21)

The diagram showing that when an economy with a domestic price below the world price ($P_W$) opens to trade, domestic price rises, quantity supplied exceeds domestic consumption, and the excess is exported.

Welfare Impact of Exporting on Domestic Groups

When an economy opens to trade as an exporter at world price $P_W$, domestic consumer surplus contracts from area $A + B$ to $A$, while producer surplus expands from area $C$ to area $B + C + D$.

Net Social Welfare Gain from Exporting (Area D)

The net addition to overall domestic social welfare (consumer surplus plus producer surplus) resulting from trade when a nation exports, represented geometrically by area $D$.

Welfare Effects of Trade for an Importing Country (Figure 22b)

The diagram showing that when a nation with a domestic price above the world price opens to trade, price drops to $P_W$, domestic consumption exceeds domestic production, imports fill the gap, and net welfare increases by area $D$.

Welfare Impact of Importing on Domestic Groups

When an economy opens to trade as an importer, domestic consumer surplus rises from area $A$ to area $A + C + D$, while domestic producer surplus falls from area $B + C$ to area $B$.

Firm

An economic actor responsible for combining labor, capital equipment, raw materials, and other inputs to supply goods and services in the economy.

Law of Supply

The microeconomic principle stating that, all else equal, as the market price of a good increases, firms are willing to supply a greater quantity of that good.

Total Revenue ($TR$)

The gross monetary earnings a firm collects from selling its output, calculated by multiplying the quantity of output sold by the market price received ($P \times Q$).

Economic Costs vs. Accounting Costs

Economic costs include the opportunity costs of all resources used in production (both explicit and forgone earnings), whereas accounting costs measure only explicit, out-of-pocket monetary expenditures.

Economic Profit vs. Accounting Profit

Accounting profit equals total revenue minus explicit monetary costs, whereas economic profit equals total revenue minus total economic costs (explicit plus implicit opportunity costs).

Bob's Bread Company Cost and Profit Calculation

With daily revenue of $\$1,200$ and explicit costs of $\$950$, Bob earns an accounting profit of $\$250$; subtracting his forgone management wage of $\$200$ yields an economic profit of $\$50$ per day.

Bob's Bread Company Cost Structure (Figure 23, Top Table)

The table detailing Bob's fixed costs of $\$250$ and variable costs rising from $\$108$ at $50$ loaves to $\$1,575$ at $450$ loaves, with the change in total cost increasing at each $50$-loaf production increment.

Fixed Costs

Expenses that do not vary with the quantity of output produced and cannot be changed in the short run, such as equipment rental and shop lease payments.

Variable Costs

Production expenses that can be adjusted in the short run and change directly as the firm alters the quantity of output supplied, such as labor wages and raw materials.

Marginal Cost ($MC$)

The additional cost incurred when producing one extra unit of output, computed by dividing the increase in total cost by the increase in output quantity ($\frac{\Delta TC}{\Delta Q}$).

Diminishing Returns to Scale

The short-run production condition where adding variable inputs (such as workers) to a fixed productive factor (such as ovens) yields progressively smaller additions to total output, causing marginal costs to rise.

Marginal Revenue ($MR$) in Perfect Competition

The incremental revenue gained from selling one additional unit of output; for a competitive price-taking firm, marginal revenue is constant and equal to the market equilibrium price.

Profit-Maximization Rule ($MR = MC$)

The operational condition dictating that a profit-maximizing firm should expand output as long as marginal revenue exceeds marginal cost, choosing the quantity where $MR = MC$.

Bob's Bread Company Profit Maximization Table (Figure 23, Bottom Table)

The table demonstrating that Bob maximizes profit at $300$ loaves of bread, where marginal revenue equals marginal cost ($MR = MC = \$4.00$), generating peak economic profits of $\$50$.

Supply Curve of a Competitive Firm

The competitive firm's upward-sloping marginal cost curve above average variable cost, reflecting rising opportunity costs of production due to diminishing returns to scale.

Market Entry and Exit Mechanism

The competitive market dynamic where positive economic profits entice new firms to enter (shifting supply right and lowering prices), while economic losses drive firms to exit until profits reach zero.

Zero Economic Profit Equilibrium

The long-run competitive state where economic profits reach zero and entry stops, yet owners remain satisfied because they earn their opportunity wage from their best alternative employment.

Allocative Role of Prices

The function of market prices in allocating scarce societal resources across industries, where prices exceeding costs signal positive profits and attract resources into expanding production.

Imperfect Competition

A market structure in which one or a few dominant firms supply the market and possess the capability to influence the market price of their products.

Market Power

The ability of a seller facing a downward-sloping demand curve to set the market price rather than taking prices as given, constrained only by the market demand curve.

Monopoly

An imperfect market structure consisting of a single supplier of a good or service, shielded from competition by barriers to entry.

Barriers to Entry

Structural, legal, or economic impediments that block potential competitors from entering a market to contest an incumbent firm's profits.

Ownership of a Key Resource

A barrier to entry occurring when a single company controls an indispensable input or distribution asset, such as DeBeers historically controlling $80\%$ of global diamond mines or a utility owning regional power grids.

Patent and Copyright Laws

Government-created legal monopolies granting an inventor the exclusive right to market a technology for $20$ years in exchange for disclosure, or granting authors exclusive rights over their creative works.

Natural Monopoly

An industry where a single firm can supply the entire market at a lower average cost than two or more firms can, driven by high fixed costs and falling average costs over the relevant range of demand.

Monopolist's Downward-Sloping Marginal Revenue

The condition where a monopolist's marginal revenue curve lies below its demand curve because expanding output requires reducing the price charged across all existing units sold.

Monopolist Profit-Maximization Diagram (Figure 25)

The graphical framework showing a monopolist finding the output where $MR = MC$ and setting the profit-maximizing price according to the height of the market demand curve at that quantity.

Monopolist's Output and Price Decision

In the Smallville cable TV example, the monopolist maximizes profit where marginal revenue equals marginal cost ($MR = MC = \$7$), supplying $700$ subscriptions and charging a price of $\$13$ per month.

Welfare Consequences of Monopoly

Monopolies generate a transfer of consumer surplus to the firm and create deadweight loss by restricting supply below the socially efficient competitive quantity where marginal cost equals consumer valuation.

Sherman Anti-Trust Act of 1890

Federal legislation passed in $1890$ enabling the U.S. government to review mergers, restrict anti-competitive business practices, and break up dominant firms to preserve market competition.

Anti-Trust Remedies

Regulatory policy measures implemented to counter monopolies, including corporate breakups (such as the $1984$ divestiture of AT&T) and operational restrictions (such as forcing Microsoft to unbundle its web browser).

Government Responses to Natural Monopolies

Public interventions to mitigate natural monopolies, including public regulatory price setting through oversight agencies and direct municipal ownership of utilities like water and sanitation.

Minnesota Live Event Ticket Law (2022)

State consumer protection legislation enacted to require price transparency in ticket sales following monopolistic market problems during the Taylor Swift Eras Tour pre-sale in November $2022$.

Price Discrimination

The business practice of selling the same good or service at different prices to different groups of buyers based on differences in their willingness to pay.

Perfect Price Discrimination

A theoretical pricing strategy where a firm charges every individual buyer the exact maximum price they are willing to pay, eliminating deadweight loss and capturing all consumer surplus.

Oligopoly

A market structure characterized by a small number of large producers supplying the vast majority of output in an industry (e.g., tennis balls, commercial airplanes, washing machines).

Strategic Interaction

The unique characteristic of oligopolies where each seller must anticipate and account for the output, pricing, and marketing choices of competing rival firms when making its own decisions.

Cartel

A formal collusive agreement among independent suppliers in an oligopolistic market to coordinate output and act as a unified monopoly to maximize industry profits.

Instability of Cartels

The inherent economic vulnerability of collusive cartels caused by individual members facing marginal revenue in excess of marginal cost ($MR > MC$), creating a persistent temptation to cheat by expanding output.

Organization of Petroleum Exporting Countries (OPEC)

An international cartel of oil-exporting sovereign nations that raised crude oil prices from $\$3.39$ a barrel in $1972$ to $\$31.77$ in $1981$, experienced a collapse below $\$10$ in $1986$, and coordinated record supply cuts in April $2020$.

Monopolistic Competition

A common market structure featuring many competing firms that sell similar but differentiated products with free entry and exit in the long run (e.g., restaurants, clothing, book publishing).

Product Differentiation

The practice of distinguishing a firm's products from those of rivals through unique recipes, quality, branding, portion sizes, or location, endowing each firm with a downward-sloping demand curve.

Long-Run Equilibrium in Monopolistic Competition

The market outcome where positive economic profits induce the entry of new firms selling substitute varieties, shifting existing firms' demand curves leftward until economic profits equal zero.

Entrepreneur

An individual who assumes financial and economic risk to create new goods, introduce innovative production methods, or establish new markets in pursuit of economic profits.

Creative Destruction

Economist Joseph Schumpeter's term describing how entrepreneurial innovation continuously dismantles and replaces established markets and monopolistic barriers, driving long-term economic growth.

Market Failure

A situation in which uncoordinated private competitive markets fail to allocate economic resources efficiently or generate socially desirable outcomes, primarily due to externalities or public goods.

Externality

An unintended side effect occurring when an individual's or firm's actions affect the well-being of a bystander without any corresponding monetary payment or compensation.

Positive Externality

A spillover benefit generated by an economic action that enhances bystander well-being, leading private markets to produce less than the socially optimal quantity (e.g., beekeeping pollinating apple orchards).

Negative Externality

An uncompensated cost or harm imposed on bystanders by an economic activity, causing private markets to supply more than the socially optimal quantity (e.g., untreated industrial waste or carbon emissions).

Social Cost of Production

The full cost to society of producing a good, calculated as the firm's private marginal cost plus the external cost imposed on third parties ($\text{Private Cost} + \text{External Cost}$).

Socially Optimal Level of Production with a Negative Externality (Figure 26b)

The graph illustrating that adding an external pollution treatment cost ($\$15$ per unit) shifts the effective supply curve upward, establishing a social optimum at a higher price and lower quantity than private equilibrium.

Optimal Level of a Negative Externality

The socially efficient volume of an externality, which is greater than zero because completely eliminating the externality would require curtailing valuable production at a cost exceeding the environmental benefits.

Market for Honey with External Benefits (Figure 27b)

The diagram showing that incorporating the positive external pollination benefit shifts the true social value curve above the private market demand curve, indicating the optimal quantity of honey exceeds private market output.

Internalizing an Externality

The process of altering economic incentives so that decision-makers bear the full social costs or benefits of their actions, such as combining related activities within a single enterprise (e.g., Netflix producing in-house content).

Coase Theorem

Ronald Coase's proposition that private parties can bargain to resolve externalities efficiently without government regulation, provided property rights are clearly assigned and transaction costs are negligible.

Reciprocal Nature of Harm

Ronald Coase's insight that externality disputes involve mutual harms: prohibiting an activity (like refinery emissions) harms the producer, whereas allowing it harms other resource users (like downstream fishermen).

Congestion Pricing

A Pigouvian tax mechanism charging drivers user fees during peak hours to internalize traffic delay externalities, approved by New York City in April $2019$ as the first system of its kind in the United States.

Tradable Emissions Permits (Cap-and-Trade)

A regulatory policy setting an aggregate cap on pollution emissions and distributing permits that firms can trade in auction markets, utilized by the EPA for sulfur dioxide and by California in $2013$ for greenhouse gases.

Tragedy of the Commons

The economic problem where open-access, jointly owned common resources are overused and depleted because individual users ignore the negative external costs of their use on other participants.

Four Types of Goods Matrix (Figure 29)

The $2 \times 2$ matrix categorizing economic goods across the two dimensions of rivalry in consumption (high vs. low) and excludability (high vs. low).

Rivalry in Consumption

The characteristic of a good whereby one person's consumption of a unit reduces the quantity or quality of that good available for others to consume.

Excludability

The characteristic of a good or service whereby sellers can easily prevent non-paying individuals from obtaining or consuming it.

Private Goods

Economic goods characterized by both high excludability and high rivalry in consumption, such as pizza, haircuts, and gasoline.

Common Resources

Economic goods that exhibit high rivalry in consumption but low excludability, making them vulnerable to overuse and depletion (e.g., ocean fish, city streets, clean environment).

Collective Goods

Economic goods characterized by high excludability but low rivalry in consumption, often provided as natural monopolies with zero marginal costs of reproduction (e.g., satellite radio, internet service, pay-per-view movies).

Public Goods

Economic goods that are both non-rival in consumption and non-excludable, making them unprofitable for private competitive markets to provide adequately (e.g., national defense, tornado sirens, radio broadcasts).

Institutions vs. Organizations

Institutions are the formal and informal rules and norms structuring human interaction (e.g., markets, tipping norms), whereas organizations are formal structured entities that organize interaction (e.g., corporations, stock exchanges).

Distinctive Powers of Government

The two unique sovereign powers possessed by government that distinguish it from private institutions: the legal authority to compel the payment of taxes and the legal monopoly on the legitimate use of physical force.

Pork Barrel Politics and Logrolling

Pork barrel politics is the tendency of legislators to secure concentrated public spending for local districts at general taxpayer expense; logrolling is the legislative practice of trading votes to pass each other's pet spending bills.

Rent Seeking

Socially unproductive activity directed at manipulating government policy or securing concentrated economic transfers without creating new wealth, such as lobbying for domestic sugar price supports or paying bribes for regulatory exemptions.