Microeconomics Exam #2

Diminishing Marginal Utility

Lowering utility as more of a product is consumed. Each marginal unit of a good consumed provides less additional utility that the previous unit.

Marginal Utility

Additional utility provided by one additional unit of consumption. Change in total utility divided by change in quantity.

Total Utility

Sum of marginal utilities, increases as more is consumed.

Marginal Utility per Dollar

Amount of additional utility received divided by the product’s price. Marginal utility divided by price.

Utility Maximizing Choice

Where marginal utility per dollar spent is the same for both goods. Continuing to purchase the next good with the highest marginal utility per dollar until the budget is exhausted. MU1/P1 = MU2/P2

Consumer Equilibrium

Utility maximizing choice, the ratio of the prices of the two goods should be equal to the ratio of the marginal utilities. P1/P2 = MU1/MU2

Substitution Effect

Occurs when a price changes and consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price. Always happens simultaneously with the income effect.

Income Effect

A higher price means, in effect, the buying power of income has been reduced, which leads to buying less of the good. Always happens simultaneously with the substitution effect.

Budget Constraint Rotates

What happens when there is a change in the price of goods, and demand changes. Means that individuals are seeking the highest utility possible.

Behavioral Economics

Enriches the economic understanding of decision making by integrating the insights of psychology into economics. Takes into account the state of mind of the consumers. Dollar amounts can mean different things to individuals depending on the situation.

Loss Aversion

Idea that humans react more to loss than gains, $1 loss pains us 2.25 times more than $1 gain helps us.

Mental Accounting

Putting dollars into mental categories where they take different values depending on the context of the situation.

Utility

Satisfaction or usefulness of a good or service.

Budget Constraint

All the possible combinations, given the price and budget, of goods that can be purchased.

Fungible

Units of a good are capable of natural substitution with each other and carry equal value to the individual. Assumption made by traditional economists.

Firm

Producer or a business that combines inputs of labor, capital, land, and raw or finished component materials to produce outputs.

Production

AKA Manufacturing - includes any process or service that creates value, including transportation, distribution, wholesale, and retail sales. Process of combining inputs to create outputs.

Profit

Total revenue minus total cost. Cost has to be less than price.

Monopolistic Competition

Market condition where many firms sell similar but not identical products.

Oligopoly

Market condition where a few firms sell similar or identical products.

Total Revenue

Income generated from selling products. Price x Quantity

Total Cost

What the firm pays for producing and selling products. Sum of fixed and variable costs.

Explicit Costs

Out-of-pocket costs or actual payments.

Implicit Costs

Opportunity costs of using resources the firm already owns, or resources that the owners contribute.

Accounting Profit

Total Revenue - Explicit Costs. Difference between dollars brought in and paid out.

Economic Profit

Total Revenue - Total Costs (Explicit and Implicit). Shows if company is economically successful.

Factors of Production

Natural resources, labor, capital, technology, and entrepreneurship. AKA Inputs

Production Function

Mathematical expression or equation that explains the engineering relationship between inputs and outputs. Q=f [ NR,L,K,t,E ] How much output can be produced with a different # of inputs. Short Hand - Q = f [L,k]

Fixed Inputs

Inputs that cannot be easily increased or decreased in a short period of time. Define the maximum output capacity.

Variable Inputs

Inputs that can be easily increased or decreased in a short period of time.

Short Run

Period of time during which at least some of the factors of production are fixed.

Long Run

Period of time which all factors or inputs are variable.

Output or Total Product

Amount produced with a given amount of labor and a fixed amount of capital.

Marginal Product

Additional output of one more worker. Change in total product divided by the change in labor.

Law of Diminishing Marginal Product

As workers are added marginal product increases at first, but eventually decreases, and eventually there is none or negative effects on output.

Factor Payments

What the firm pays for the use of the factors of production. Costs for the firm.

Cost Function

Mathematical expression that shows the cost of producing different levels of output. Cost rises as the firm produces more output. Depends on how much labor and capital the firm uses.

Average Cost

Total cost divided by quantity of output produced. AC = TC/Q Cost on average of producing a given quantity.

Marginal Cost

Cost of each individual unit produced cost of producing one more unit. Change in total cost divided by change in output. Curve is generally upward sloping.

Fixed Costs

Costs of fixed inputs, expenditures that do not change regardless of the level of production. Incurred even when the output is zero. Ex. rent, production equipment, advertising expense

Variable Costs

Costs of variable inputs, increase or decrease with output.

Average Total Cost

Total cost divided by the quantity of output. Curve is typically “U” shaped.

Average Variable Cost

Divide variable cost by quantity of output. Curve lies below curve for average total cost, doesn’t include fixed costs. Typically upward sloping/”u” shaped.

Average Profit

Profit divided by quantity of output. Price - Average Cost. AKA Profit Margin. Total revenue - total cost

Positive Profit Margin

Market Price > Average Cost

Negative Profit Margin

Market Price < Average Cost

Economies of Scale

As the quantity of output increases the cost per unit declines.

Long Run Average Cost Curve

Curve that allows for all factors of production to change. Based on a group of short-run average cost curves. Shows least expensive average costs for any level of output. (LRAC) Shape of the curve determines what size the competitors in the market can be and how many. Can be shifted with new developments in production tech.

Constant Returns to Scale

When economies of scale are exhausted and expanding inputs no longer changes the average cost of production.

Diseconomies of Scale

As the level of output and the scale rises average costs rise as well.

Flat Bottom LRAC Curve

Competitors can be different sizes in the market.

Single Point Bottom to LRAC Curve

Competitors will be the same size in the market.

Perfect Competition

Market condition where many firms produce identical products with many buyers and sellers for the product. Buyers and sellers have all relevant information to make rational decisions about the product they are buying or selling, and firms can enter or leave the market without any restrictions. The demand curve in this situation is perfectly elastic. The supply curve is equal to the marginal cost curve. Causes productive and allocative efficiency. Merely hypothetical.

Price Taker

When competing pressure forces firms to accept the prevailing equilibrium market price. Applies to perfectly competitive firms. Supply and demand solely determines market price.

Profit Maximizing Output

Occurs where MR=MC and P=MC. Quantity where the difference between total revenue and total costs is the largest.

Breakeven Point

Where the price a firm receives is exactly equal to its average cost of production. Zero profit. Price intersects MC at the minimum point of the AC curve.

Shutdown Point

Intersection of the average variable cost curve and the marginal cost curve. Price is lower than variable costs. Price < min. average variable cost.

Loss

Where the price intersects the MC below the AC curve. The price is above the shutdown point but below breakeven.

Entry

New firms enter the industry in response to increased industry profits.

Exit

Long-run process of reducing production in response to a sustained pattern of losses.

Long-run Equilibrium

All firms earn zero economic profits when producing at the output level where P=MR=MC=AC. Process of entry and exit drives the price in a perfectly competitive market to the zero-profit point.

Constant Cost Industry

When demand rises the cost of production stays the same.

Increasing Cost Industry

When demand increases the cost of production also increases.

Decreasing Cost Industry

When demand increases the cost of production decreases.

Allocative Efficiency

The combination of goods and services produced reflects the combination that society most desires. Has to be a productive efficiency.

Market Structure

Conditions in an industry - # of sellers, ease of entry, type of products sold.

Monopoly

Market condition where there is no competition and firms have a great deal of market power. One firm produces all of the output in a market and can charge any price it wants. Impossible for competitors to gain a foothold in the market. Not allocatively efficient, but promotes innovation.

Barriers to Entry

Legal, technological, or market forces that discourage or prevent potential competitors from entering into a market.

Natural Monopoly

When economies of scale are larger relative to the quantity demanded in the market. Marginal costs of adding an additional customer is low. One producer serves the entire market more efficiently a number of smaller producers with duplicate physical capital investments. Smaller local markets, products difficult to transport, company w/ control of a scarce physical resources.

Legal Monopoly

When the government erects barriers to entry by prohibiting or limiting competition. Mostly utilities, and supporting innovation.

Utilities

Socially beneficial products necessary for everyday life.

Patent

Gives inventor exclusive legal right to make, use, or sell invention for a limited time. (20 years)

Trademark

Identifying symbol or name for a particular good. (renewed every 10 years)

Copyright

Protection for original works of authorship, can’t reproduce, display, or perform without permission. (Life of author + 70 yrs)

Trade Secrets

Business secrets/methods of production that cannot be stolen.

Intellectual Property

Ownership over an idea, concept, or image. Protects the rights of inventors.

Deregulation

Eliminated or reduced restrictions on enforcing legal monopolies.

Predatory Pricing

Firm uses threat of sharp price cuts to discourage competition. Violation of the anti-trust laws.

Monopoly Market Demand Curve

Downward sloping curve.