Intro to Micro Test 2

explicit costs

paid by money

implicit costs

opportunity cost of using self-owned resources

accounting revenue =

revenue - explicit costs

economic profit =

accounting profit - implicit costs

short run

same variable inputs and fixed plant size

long run

all inputs are variable and firms can adjust plant size as well as enter/exit the industry

marginal product =

change in total product / change in labor input

average product =

total product / untis of labor

law of diminishing returns

resources are of equal quality, technology is fixed, variable resources are added to fixed resources, and at some point, marginal product will fall

fixed costs

costs that do not vary with output

variable costs

costs that do vary with output

total cost =

total fixed cost + total variable cost

average fixed cost =

TFC/Q

Average variable cost =

TVC/Q

average total cost =

TC/Q; also = AFC + AVC

marginal cost =

change in total cost / change in quantity

where does MC intersect with AVC and ATC?

MC intersects with AVC at minimum AVC and intersects with ATC at minimum ATC

long-run production costs

the firm can change all input amounts, including plant size. All costs are variable in the long-run, and now consider costs in terms of average costs

economies of scale

larger outputs decrease costs. Labor specialization, managerial specialization, efficient capital, and other factors

constant returns to scale

as you produce more, cost of production stays the same

diseconomies of scale

as you produce more, cost of production rises. control and communication problems, coordination problems, and worker alienation

minimum efficient scale

the lowest output level where you’re minimizing your average costs. this can determine the structure of the industry

4 market models

pur competition, monopolistic competition, oligopoly, pure monopoly

pure competition

large number of firms, homogeneous product, no control over price, easy to enter market, no nonprice competition, perfectly elastic demand, each firm is a “price taker”

total revenue =

P x Q

Profit maximization (TR-TC approach)

producer will wish to produce at the output level where total revenue exceeds total cost by the greatest amount. Need to identify the break even point

profit maximization (MR=MC approach)

for a price taker, price = marginal revenue = marginal cost

loss minimizing case

still produce because MR>minimum AVC. Loss at a minimum where MR = MC, and producing adds more to revenue than to costs

should PC firm produce in the short run?

Yes if P>=AVC

What quantity should PC firm produce if P>=AVC?

where MR = MC

is a PC firm making a profit?

yes if MR = P>ATC

short-run supply

as long as P exceeds the minimum AVC, the firm continues to produce using the rule MR = MC

long run for PC firms

firms can expand or contract capacity and firms can enter or exit the industry

constant-cost industry

cost of production is the same no matter how many firms are in the industry (most industries are not this way). constant resource prices and entry/exit does not affect long-run ATC

long-run equilibrium for PC

entry eliminates profits (firms enter, supply increases, and price falls), exit eliminates losses (firms leave, supply decreases, and price rises)

increasing cost industries

the long-run ATC increases with expansion, and there’s specialized resources

productive efficiency

producing where P = minATC

allocative efficiency

producing where P = MC

triple equality

where P = MC = minATC

purely competitive markets will automatically adjust to:

changes in consumer tastes, resource supplies, technology, and “the invisible hand”

creative destruction

the creation of new products and methods may destroy the old products and methods

pure monopoly

single seller, no close substitutes, price maker, non-price conpetittion (mostly PR and advertising), barriers to entry

barriers to entry for pure monopoly

economies of scale, legal barriers like patents or licenses, ownership or control of essential resources, pricing and other strategic barriers

monopoly demand curve

monopolistic demand curve is the market demand curve, it is downward sloping, and MR<P

economic effects of monopoly

income transfer (from consumer to the monopolist), cost complications (simultaneous consumption, network effects, X-inefficiency, and rent-seeking behavior)

network effects

as more users adopt a technology, it becomes more useful

X-inefficiency

no competitive pressure to produce at the lowest possible cost

rent-seeking behavior

an individual, company, or organization tries to increase their wealth or financial gain by manipulating social, political, or economic conditions rather than by creating new products, services, or economic value

government interventions of pure monopolies

antitrust laws, regulating price and quantity (usually necessity goods or goods with positive eternalities), ignore the monopoly

socially optimal price

set price equal to marginal cost

fair return price

set price equal to average total cost

price discrimination

charging different buyers different prices that are not based on cost differences

conditions for success in price discrimination

monopoly power, market segregation, and no resale

monopolistic competition

relatively large number of sellers, product differentiation, easy entry and exit, and nonprice competition like advertising

4-firm concentration

percentage of sales by the 4 largest firms of an industry. CR = output of 4 largest firms / total output of industry

Herfindahl Index

sum of squared market shares. HI = (%S1)² + (%S2)² +…+ (%Sn)²

elasticity of demand for monopolistic competition

highly elastic, more than pure monopoly. there are substitutes, but not perfect substitutes. MR<D

long-run profit of monopolistic competition

only a normal profit because of entry and exit of firms

efficiency of monopolistic competition

productively inefficient because P>minATC and allocatively inefficient because P>MC

advantage of monopolistic competition

PRODUCT VARIETY: the firm constantly manages price, product, and advertising (makes better product differentiation and better advertising), consumer benefits from the greater array of choices and better products (types and styles, brands and quality)

oligopoly

a few large producers that dominate the market; there can be homogeneous or differentiated oligopolies; limited control over price, strategic behavior, mutual interdependence, and entry barriers and mergers; shortcomings, localized markets, interindustry competition, import competition, and dominant firms.

How to know if an industry is an oligopoly

if the 4 firm concentration ratio is greater than or equal to 40

behavior of oligopolies

game theory, collusion, incentive to cheat, and prisoner dilemma

nash equilibrium

outcome from which neither firm wants to deviate. Viewed as an optimal strategy with a stable and persistent outcome

credible threats

a threat that is believable by the other firm; can establish collusive agreements; a strong enforcer can prevent cheating; can generate higher profits; may be countered with threat by rival

empty threats

unbelievable by rivals

kinked demand curve

happens with a non-collusive oligopoly; uncertainty about rivals’ reactions (match price decrease and ignore increase); assu