Micro Exam 5

firms seek to…

maximize their profit

profit=

revenue-cost

costs are either…

explicit or implicit

require an outlay of money (literally spend money) e.g paying wages to workers: pay rent to landowners

explicit costs

not actual payment (opportunity cost of owners time, opportunity cost of owners assets)

implicit costs

do not require an outlay of money (represent incomes that are given up, no actual monetary payements)

opportunity costs

total cost=

explicit cost + implicit cost

accounting profit=

total revenue- explicit costs

economic profit=

total revenue-explicit cost-implicit cost

increase in total cost arising from an extra unit of production (how much additional cost if produce one more unit)

marginal cost

marginal cost=

change in total cost/ change in quantity

average cost=

total cost/ quantity

do not vary with the quantity of output produced (many of them are overhead costs)

fixed costs

vary with the quantity of output produced 

variable cost

total cost=

fixed cost+variable cost

costs in the short run some inputs are…

fixed costs (factories, land, assembly lines)

costs in the long run all inputs…

are variable (no fixed costs)

long run average total costs falls as the quantity of output increases (When a business produces more, the cost per unit goes down.)

economies of scale

long run average total cost stays the same as the quantity of output changes (If a bakery doubles its workers and doubles its ovens, it bakes exactly twice as much bread — no cheaper, no more expensive per loaf.)

constant return to scale

long run average total cost rises as the quantity of output increases

diseconomies of scale

A simple rule that shows how much output a firm can produce with different amounts of inputs (like labor, machines, materials)

production function

The extra amount of output you get when you add one more unit of an input (like one more worker).

marginal product 

marginal product of an input declines as the quantity of the input increases

diminishing Marginal product of labor

there are 4 market structures

competitive market
monopoly
oligopoly
oligopolistic competition

Lots of sellers and buyers

Products are very similar (or identical)

Free entry and exit from the market

Prices are determined by supply and demand

competitive market

in a competitive market
total revenue=

price x quantity

in a competitive market
average revenue=

total revenue / quantity

in a competitive market
marginal revenue=

change in total revenue/ change in quantity

find the optimal quantity to maximize profit

profit maximization condition

when MR=MC, profit is…

maximized

in a … can keep increasing its output without affecting the market price

competitive market

a short run decision not to produce anything temporarily

shutdown

a long run decision to leave the market permanently

exit

if shutdown in short run, vc is saved but…

you still have to pay for fixed costs

if exit in the long run, zero costs…

total cost is saved

shut down if…

TR<VC or P<AVC

keep operating if…

TR>VC or P>AVC

Make zero economic profit

Produce efficiently at minimum cost

Charge a price equal to marginal cost

Horizontal market supply curve

long run properties of a competitive market

Firms earn just enough to cover all costs, including normal profit (the opportunity cost of the owner’s time and resources).

zero profit

This ensures allocative efficiency — goods are produced in the exact quantity consumers want at the right price.

price equal to marginal cost

a cost that has already been committed and cannot be recovered

sunk cost

a firm that is the sole seller of a product without a close substitute

monopoly

a competitive market has no…

market power

3 barrier to entry in monopoly

monopoly resources
government regulation
natural monopoly

a single firms owns a key resources
(DeBeers owns most of the worlds diamond mines)

monopoly resources

the government gives a single firm the exclusive right to produce the good (patents, copyright)

government regulation

a single firm can supply the entire market at lower cost than could several firm

natural monopoly: economies of scale

how does a monopolist maximize profit

Set output where MR = MC

Then charge price from the demand curve

P > MR = MC

Profit = (P − ATC) × Q

-charge different prices to different customers(based on different willingness to pay)
-selling the same good at different prices to different buyers
-does not hurt economy

price discrimination

buyers in the low priced market resell the good to potential buyers in the high priced market

arbitrage

“perfect price discrimination”
knows every buyers WTP
charges price=everyone WTP

first degree price discrimination

quantity discount
$3 each but 4 for $10
buy one for 50%

second degree price discrimination

different groups of people have different willingness to pay and are charged different prices
(student discount, coupons)

third degree price discrimination

prevent companies from coordinating their activities to make markets less competitive

increasing competition with antitrust laws (public policy toward monopolies)

regulate the behavior of monopolist
-set the monopolist price

regulation (public policy toward monopolies)

how the ownership of the firms affects the cost of the production (private owners: incentive to min cost) (public owners(government): less efficient since no profit motive to minimize costs)

public ownership (public policy toward monopolies)

some economists argue that is often best for the government not to try to remedy the inefficiencies of the monopoly pricing

do nothing (public policy toward monopolies)