Introduction to Microeconomics Exam 2

Units 6-10

Total Utility 

The total satisfaction a consumer derives from consumption; it could refer to either the total utility of consuming a particular good or the total utility from all consumption.

Marginal Utility

The change in total utility derived from a one-unit change in consumption of a good.

Law of Diminishing Marginal Utility

The more of a good a person consumes per period, the smaller the increase in total utility from consuming one more unit (o.t.c). 

Consumer Equilibrium

The condition in which an individual’s consumer budget is spent and the last dollar spent on each good yields the same marginal utility; therefore, utility is maximized. 

Marginal Valuation

The dollar value of the marginal utility derived from consuming each additional unit of a good.

Consumer Surplus

The difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays.

Indifference Curve

Shows all combinations of goods that provide the consumer with the same satisfaction, or the same utility (the consumer finds all combinations on a curve equally preferred).

Marginal Rate of Substitution

The number of “A” you are willing to give up to get more of “B,” neither gaining nor losing utility in the process.

The Law of Diminishing Rate of Substitution

States that as your consumption of “A'“ increases, the amount of “B” you are willing to give up to get another “A” declines. 

Indifference Map

A graphical representation of a consumer’s tastes. Each curve reflects a different level of utility.

Properties of Indifference Curves

1. A particular indifference curve reflects a constant level of utility, so the consumer is indifferent about all consumption combinations along a given curve. Combinations are equally attractive.

2.       If total utility is to remain constant, an increase in the consumption of one good must be offset by a decrease in the consumption of the other good, so each indifference curve slopes downward.

3.       Because of the law of diminishing marginal rate of substitution, indifference curves bow toward the origin.

4.       Higher indifference curves represent higher levels of utility.

5.       Indifference curves do not intersect.

Budget Line

Depicts all possible combinations of videos and pizzas, given their prices and your budget.

Consumption Function

The relationship between consumption and income, (o.t.c).

Marginal Propensity to Consume (MPC)

The fraction of a change in income that is spent on consumption; the change in consumption divided by the change in income that caused it.

Marginal Propensity to Save (MPS)

The fraction of a change in income that is saved; the change in income that caused it.

Saving Function

The relationship between saving and income (o.t.c).

Net Wealth

The value of assets minus liabilities.

Life-Cycle Model of Consumption and Saving

Young people borrow, middle-agers pay off debts and save, and older people draw down their savings; on average, net savings over a lifetime are small.

Investment Function

The relationship between the amount businesses plan to invest and the economy’s income, (o.t.c).

Autonomous

A term that means “independent,” for example, autonomous investment is independent of income.

Government Purchase Function

The relationship between government purchases and the economy’s income, (o.t.c).

Net Exports

The relationship between net exports and the economy’s income (o.t.c).

Explicit Cost

Opportunity cost of resources employed by a firm that takes the form of cash payments.

Implicit Costs

A firm’s opportunity cost of using its own resources or those provided by its owners without a corresponding cash payment.

Accounting Profit

A firm’s total revenue minus its explicit costs.

Economic Profit

A firm’s total revenue minus its explicit and implicit costs.

Normal Profit

The accounting profit earned when all resources earn their opportunity cost.

*The problem is if you are not making a normal profit (paying your debts down and end up making a profit), then your investors will go elsewhere. 

Variable Resources

Any resource that can be varied in the short run to increase or decrease production.

Ex. Labor, hiring or cutting of labor. 

Fixed Resource

Any resource that cannot be varied in the short run, take about a year to get into place.

Ex. New machinery because it takes a while to get, produce, transport, etc.

Short Run

A period during which at least one of a firm’s resources is fixed (it can’t be changed), 3-6 months.

Long Run

A period during which all resources under the firm’s control are variable, 1 year.

Total Product

The total output produced by a firm

Production Function

The relationship between the amount of resources employed and a firm’s total product. 

Marginal Product

The change in total product that occurs when the use of a particular resource increases by one unit, all other resources are constant.

Increasing Marginal Return

The marginal product of a variable resource increases as each additional unit of that resource is employed. 

Law of Diminishing Marginal Return

As more of a variable resource is added to a given amount of a fixed resource, marginal product eventually declines and could become negative.

*If you add too many people, the work ends up inefficient aka marginal product declines. More is not better. 

Fixed Cost

Any production cost that is independent of the firm’s rate of output.

Variable Cost

Any production cost that changes as the rate of output changes.

Total Cost

The sum of fixed cost and variable cost, or TC = FC + VC

Average Variable Cost

Variable cost divided by output, or AVC = VC/q (quantity)

Average Total Cost

Total cost divided by output, or ATC = TC/q; the sum of average fixed cost and average variable cost, or ATC = AFC + AVC.

Long-Run Average Cost Curve

A curve that indicates the lowest average cost of production at each rate of output when the size, or scale, of the firm varies; also called the planning curve.

Economies of Scale

Forces that reduce a firm’s average cost as the scale of operation increases in the long run.

Diseconomies of Scale

Forces that may eventually increase a firm’s average cost as the scale of operation increases in the long run. 

Constant Long-Run Average Cost

A cost that occurs when, over some range of output, long-run average cost neither increases nor decreases with changes in firm size.

Production Function

Identifies the maximum quantities of a particular good or service that can be produced per time period with various combinations of resources, for a given level of technology. 

Isoquant Curve

A curve that shows all the technologically efficient combinations of two resources, such as labor and capital, that produce a certain rate of output.

Properties of Isoquants

o   Isoquants farther from the origin represent greater output rates.

o   Isoquants have negative slopes because, along a given Isoquant, the quantity of labor employed inversely relates to the quantity of capital employed.

o   Isoquants do not intersect because each isoquant refers to a specific rate of output.

o   Isoquants are usually convex to the origin.

Marginal Rate of Technical Substitution (MRTS)

The rate at which labor substitutes for capital without affecting output.

Isocost Line

Identifies all combinations of capital and labor the firm can hire for a given total cost. 

Expansion Path

The line formed by connecting tangency points.

Market Structure

Important features of a market, such as the number of firms, product uniformity across firms, firms’ ease of entry and exit, and forms of competition. 

Perfect Competition

A market structure with many fully informed buyers and sellers of a standardized product and no obstacles to entry or exit of firms in the long run. 

Commodity

A standardized product, a product that does not differ across producers, such as bushels of wheat or an ounce of gold.

Price Taker

A firm that faces a given market price and whose quantity supplied has no effect on that price; a perfectly competitive firm. 

Marginal Revenue

The change in total revenue from selling an additional unit; in perfect competition, marginal revenue is also the market price.

Golden Rule of Profit Maximization

To maximize profit or minimize loss, a firm should produce the quantity at which marginal revenue equals marginal cost; this rule holds for all market structures. 

Average Revenue

Total revenue divided by output, or AR = TR/q; in all market structures, average revenue equals the market price.

Short-Run Firm Supply Curve

A curve that shows the quantity a firm supplies at each price in the short run; in perfect competition, that portion of a firm’s marginal cost curve that intersects and rises above the low point on its average variable cost curve. 

Short-Run Industry Supply Curve

A curve that indicates the quantity supplied by the industry at each price in the short run; in perfect competition, the horizontal sum of each firm’s short-run supply curve. 

Long-Run Industry Supply Curve

A curve that shows the relationship between price and quantity supplied by the industry once firms adjust fully to any change in market demand.

Constant-Cost Industry

An industry that can expand or contract without affecting the long-run per-unit cost of production; the long-run industry supply curve is horizontal.

Increasing-Cost Industry

An industry that faces higher per-unit production costs as industry output expands in the long run; the long-run industry supply curve slopes upward. 

Producer Efficiency

The condition that exists when market output is produced using the least-cost combination of inputs; minimum average cost in the long run. 

Allocative Efficiency

The condition that exists when firms produce the output most preferred by consumers; marginal benefit equals marginal cost. 

Producer Surplus

A bonus for producers in the short run; the amount by which total revenue from production exceeds variable costs.

Social Welfare

The overall well-being of people in the economy; maximized when the marginal cost of production equals the marginal benefit to consumers. 

Monopoly

A sole supplier of a product with no close substitutes.

Barrier to Entry

Any impediment that prevents new firms from entering an industry and competing on an equal basis with existing firms. 

Patent

A legal barrier to entry that grants the holder the exclusive right to sell a product for 20 years from the date the patent is filed.

Innovation

The process of turning an invention into a marketable product.

Economies of Scale

·       ALREADY DEFINED

·       Sometimes a monopoly occurs when a firm experiences economies of scale, as reflected by a downward-sloping, long-run average cost curve,

 [Exhibit 1]

-            Electricity

Price Maker

A firm that must find the profit-maximizing price when the demand curve for its output slopes downward. A monopolist is a price maker.

Deadweight Loss of a Monopoly

Net loss to society when a firm with market power restricts output and increases the price. 

Rent Seeking

Activities undertaken by individuals or firms to influence public policy in a way that increases their incomes. 

Price Discrimination

Increasing profit by charging different groups of consumers different prices for the same product.

Perfect Price Discrimination

Charging a different price for each unit sold.

What does the US Post Office maintain a monopoly on?

First Class letters.

Monopolistic Competition

A market structure with many firms selling products that are substitutes but different enough that each firm’s demand curve slopes downward; firm entry is relatively easy. 

·       These types of firms are PRICE MAKERS

·       Barriers to entry are low

·       But there are enough sellers that they behave competitively

·       They can act independently or interdependently

Product Differentiation

(Products differentiate themselves in four basic ways):

·       Physical Differences: packaging, colors, weight, et. al

·       Location: spatial differential, price/convenience stores

·       Services: free delivery, guarantees, toll-free numbers

·       Product Image: endorsements, all natural, Starbucks, image/brand loyalty, environmentally friendly

Excess Capacity

The difference between a firm’s profit-maximizing quantity and the quantity that minimizes average cost. [In monopolistic competition, firms fall short of producing the quantity that would achieve the lowest average cost… as opposed to perfect competition]

Oligopoly

A market structure characterized by a few firms whose behavior is interdependent.

Undifferentiated Oligopoly

An oligopoly that sells a commodity or a product that does not differ across suppliers, such as an ingot of steel or a barrel of oil. 

Differentiated Oligopoly

An oligopoly that sells products that differ across suppliers, such as automobiles or breakfast cereal.

Collusion

An agreement among firms to increase economic profit by dividing the market or fixing prices.

Cartel

A group of firms that agree to coordinate the production and pricing decisions to act like a monopolist.

Price Leader

A firm whose price is adopted by other firms in the industry.