Econ 211 UTK Test 2

Budget Line

Illustrates the combinations of two goods that can be purchased with a given income and the prices of each good.

Slopes downward.. because to buy more of good 1, a consumer has to buy less of good 2.

As a particular budget line, the prices faced by the consumer and the consumer's income held constant

Utility

A hypothetical measure of the satisfaction one receives from consuming a good or service.

Marginal Utility

The additional satisfaction from consuming one more unit of a good or service.

Falls because of diminishing returns and can become negative.

The change in utility from consuming one additional unit of good

What usually decreases as consumption increases

Total Utility

The total satisfaction from consuming a given quantity of a good or service.

Rises at a decreasing rate, then falls.

What economist assume that rational consumers seek to maximize

What usually increases as consumption increases

Law of Diminishing Marginal Utility

As one consumes more of a given product, the additional satisfaction from each additional unit falls.

Utility Maximization Rule

Individuals maximize total satisfaction when consuming where the marginal utility per dollar is equal for all goods and services.

MU(a)/P(a) = MU(b)/P(b) = ...

max utility

is where marginal utility equals zero

Behavioral Economics

The study of how human psychology enters into economic behavior as a way to explain why individuals sometimes act in predictable ways counter to economic models.

Five Psychological Factors Influencing Economic Behavior

1. Sunk Cost Fallacy

2. Framing Bias

3. Overconfidence

4. Overvaluing the Present Relative to Future

5. Altruism

Sunk Cost Fallacy

Decisions are influenced by costs already incurred instead of how the decision affects current well-being. (Refusing to drop a class because tuition is already paid.)

Framing Bias

Techniques used to steer individuals to making one decision over another. (Buy one, get one 50% off vs. 25% off purchase.)

Overconfidence

Example: Many gym memberships go unused because ambition exceeds follow-through.

Overvaluing the Present Relative to Future

Example: Not saving enough for retirement.

Altruism

Example: Why do people leave generous tips if it does not affect the quality of service already provided?

According to Marginal Utility Theory, Consumers Maximize Satisfaction When They:

Equalize marginal utility per dollar for all goods.

A Sushi Roll Costs $8 and Gives 25 Utils; Sashimi costs $4 and Gives 10 Utils. Which item should one consume next?

One should consume sushi, because it achieves 3.125 utils per dollar, while sashimi only provides 2.5 utils per dollar.

The Principle of Diminishing Marginal Utility can be Used to Explain:

Why Todd's second soda is less enjoyable than his first.

What Behavioral Factor(s) Explain(s) Why Investors are Often Reluctant to Sell Assets at a Loss?

It is related to two factors: Sunk cost fallacy and overconfidence.

Which of the Following is a Major Critique of Marginal Utility Theory?

It is difficult to measure the utility of goods consumed.

Zach continues skiing in spite of blizzard condition because he has already paid for a nonrefundable all -day pass

Sunk Cost Fallacy

Firm

An economic institution that transforms inputs to goods and services for consumers.

Must determine what a market wants and how to produce the good or service.

Types of Firms

Sole Proprietorships,

Partnerships,

Corporations.

Sam lowered the price of coffee at his grocery store from $10.00 to $9.99 per can. Consumers now purchase significantly more cans of coffee at his store

Framing Bias

After negotiating for days, Alee realize she was not worth as much to her potential employer as she had previously believed

Overconfidence

Madison was pleased that she was able to donate $100 to her favorite charity this year

Altruism

Sole Proprietorships

One owner,

Easy to start,

Limited access to financial capital,

Owner's personal assets subject to unlimited liability.

Partnerships

More than one owner,

Can divide tasks among partners (division of labor),

Personal assets of all owners subject to unlimited liability (includes negligence by partners.

Most American business are this form of business

Sole propietorship

Limited liability encourages investors to invest large amounts of money in this form of business

corporation

It is argued that this form of business contributes the most to increases in the nation's output (GDP)

Corporation

Ownership is distributed among a a small number of people. This type of business is subject to unlimited liability

partnership

Shareholders are the owners of this form of business

Corporation

Corporations

Owners called stockholders,

Have legal rights (much like an individual),

Can raise money by issuing stocks and bonds,

Owners protected by limited liability (losses limited to value of stock).

The Goal of Businesses is to Maximize Profits

Profits = Total Revenue - Total Cost

Revenue = Price Per Unit x Quantity

Economic Costs

Include both explicit and implicit costs.

typically lower than accounting profit

Explicit Costs

Expenses paid directly to some entity (wages, lease payments, raw materials, taxes, etc.).

Implicit Costs

Opportunity costs of using resources (depreciation, asset depletion, forgone wages).

Accounting Costs:

Include only explicit costs.

Accounting Profit

Total revenue - explicit costs

Economic Profit

Total revenue - explicit costs - implicit costs

Normal Rate of Return

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

If a firm's rate of return on capital falls below the normal rate of return, investors will put their funds to use elsewhere.

A Firm Earns an Economic Profit when:

Profits are greater than zero after implicit costs are considered.

A normal profit equals an economic profit of zero.

What is the primary difference between accounting profits and economic profits?

accounting profits ignore implicit costs; economic profits consider them

Short Run

Period when at least one factor of production is fixed and cannot be altered.

Long Run

Period sufficient for a firm to adjust all factors of production, including plant capacity.

Perfect Competition

Number of Firms: Many

Type of product: Identical

Ease of Entry: High

Examples of Industries: Growing Wheat/ Growing Apples

Monopolistic Competition

Number of Firms: Many

Type of Product: Differentiated

Ease of Entry: High

Example of Industries: Clothing Stores/ Restarurants

Oligopoly

Number of Firms: Few

Type of Product: Identical or Differentiated

Ease of Entry: Low

Examples of Industries: Manufacturing computers/ manufacturing automobiles

Duopoly

Number of Firms: Two

Type of Product: Identical or Differentiated

Ease of Entry: Low

Examples of Industries: Credit Cards (Visa and mastercard)

Monopoly

Number of Firms: One

Type of Product: Unique

Ease of Entry: Entry Blocked

Examples of Industries: First Class Mail Delivery

Tap Water

Production

The process of turning inputs into outputs. The cost structure depends on the nature of the production process.

In order to produce more cookies, Mrs. Meadows asks her third shift to work overtime

Short Run

Purpleberry Frozen Custard has 11,000 of fixed cost and 45,000 of variable costs

Short Run

This is a period of time during rhich a firm is unable to increase or decrease its amount of capital

Short Run

Newton Bros Bagel opens a new store on the other side of town

Long run

Because of dismal sales last year, half of the city's donut shop exit the industry

Long Run

Marginal Product

The change in output resulting from a one-unit increase in labor (change in Q/change in L). Initially rises as more workers are hired, then falls as diminishing returns set in.

Average Product

Total output divided by the amount of labor input (Q/L). Total output divided by the number of workers

Fixed Costs

Do not vary with the quantity produced.

Building a cruise ship is a fixed cost that does not depend on the number of passengers who will travel on it.

ex:lease, industrial equipment costs, interest on current debt, insurance costs,salaries of executive

Variable Costs

Rise as the level of output increases.

Food preparation is a variable cost on a cruise ship: the more passengers the greater the food cost.

Total Costs

The sum of fixed and variable costs (TC = FC + VC).

Sunk Costs

Already incurred; cannot be recovered. Rational decisions about future profits ignore sunk costs.

Marginal Cost

The change in total cost from the production of one more unit of output (MC = chang in T*C/change in Q).

Average Cost

A measure of productivity (in terms of cost efficiency).

Average Fixed Cost

FC/Q

Average Variable Cost

VC/Q, the sum of all costs that change as output changes divided by the number of units produced

Average Total Cost

Change in TC/Change in Quantiy

The amount by which total cost increases when an additional unit is produced

Change in total cost

divided by change in output

In the long run:

All inputs can be adjusted, therefore, there are no fixed costs in the long run.

Economies of Scope

Producing interdependent products helps to reduce production and marketing costs.

Average (total) cost

total cost/ quantity

Total cost is divided by the quantiy of output

Example of an Explicit Cost:

Raw material expenditures

Why do Some Stores Go Out of Business Even as They are Earning a Positive Accounting Profit

Making an accounting profit does not guarantee a successful business, because many opportunity costs are not factored into accounting profit. For example, if one works 80 hours per week running a sole proprietorship and earns only a small accounting profit, it is likely that economic profit is negative.

Suppose that a car manufacturer discovers that it can lower its average costs if it diversifies its operation by also producing pickup trucks and SUVs.

What concept does this illustrate?

Economies of scope

Example of a Fixed Cost

A lease on a building.

What are some Fixed Costs and Variable Costs Incurred by Ski Resorts?

Fixed costs include maintaining the chair lifts and operating the snow making equipment; costs that do not vary with the number of skiers. Variable costs include food, staff wages, and other costs that increase with the number of skiers.

If a Bakery can Produce 100 Cupcakes for $100 and 200 Cupcakes for $150, what is the Marginal Cost per Cupcake for the Additional 100 Cupcakes?

$0.50

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By observing a few industry characteristics, we can predict:

Pricing and output behavior.

Market Structure Depends on:

Number of firms, nature of product, barriers to entry, control over price.

Primary Market Structures

Perfect competition, monopolistic competition, oligopoly, monopoly.

The Corn and Wheat Industries are Examples of:

Perfect Competition

Characteristics of Perfect Competition

Many buyers and sellers, homogeneous products,

no barriers to market entry or exit, no long-run economic profit,

no control over price.

The Restaurant Industry is an Example of:

Monopolistic Competition

Characteristics of Monopolistic Competition

Many buyers and sellers,

differentiated products,

little to no barriers to market entry or exit,

no long-run economic profit,

some control over price.

The Automobile Industry is an:

Oligopoly

Characteristics of Oligopoly

Relatively few firms,

interdependent decision making,

substantial barriers to market entry,

potential long-run economic profit,

shared market power,

considerable control over price.

The NFL is a:

Monopoly

Characteristics of Monopoly

One firm,

no close substitutes for product,

nearly insuperable barriers to entry,

potential long-run economic profit,

substantial market power and control over price.

In a Perfectly Competitive Market, Each Firm is a:

Price taker.

Marginal Revenue

The change in total revenue that results from the sale of one additional unit of a product.

A Firm Maximizes Profit by:

Producing at the point where marginal revenue equals marginal cost.

Five Steps to Maximizing Profit:

Step 1: find MR=MC

Step 2: find optimal Q

Step 3: find optimal P

Step 4: find ATC

Step 5: find profit

Short Run

At least one factor of production is fixed.

Long Run

All factors are variable. Firms enter in response to profits and exit in responses to losses.

Loss Minimization:

When price < ATC, firms minimize losses by producing if P > AVC or shut down if P < AVC.

Productive Efficiency

Goods are supplied at the lowest possible cost.

Allocative Efficiency

Mix of goods and services is just what society desires.

Increasing-Cost Industry

As industry expands, demand for raw materials, such as precious metals, increases prices.

Decreasing-Cost Industry

As industry expands, economies of scale result in lower prices.

Constant-Cost Industry

Expands in the long run without significant changes in cost (fast food restaurants).