Econ test 4

Economists normally assume that the goal of a firm is to

maximize its profit.

Profit is defined as total revenue

minus total cost.

The amount of money that a wheat farmer could have earned if he had planted barley instead of wheat is

an implicit cost

Katherine gives piano lessons for $15 per hour. She also grows flowers, which she arranges and sells at the local farmer’s market. One day she spends 5 hours planting $50 worth of seeds in her garden. Once the seeds have grown into flowers, she can sell them for $150 at the farmer’s market. Katherine’s accounting profits are

$100, and her economic profits are $25.

Kate is a florist. Kate can arrange 20 bouquets per day. She is considering hiring her husband William to work for her. William can arrange 18 bouquets per day. What would be the total daily output of Kate’s firm if she hired her husband?

38 bouquets

Eldin is a house painter. He can paint three houses per week. He is considering hiring his friend Murphy. Together, Eldin and Murphy can paint five houses per week. What is Murphy’s marginal product?

2 houses

The total cost of producing 3 pitchers of lemonade is $5. The total cost of producing 4 pitchers of lemonade is $7. What is the marginal cost of the 4th pitcher of lemonade?

$2

Pieology Pizzeria rents out the space of their restaurant for $500 a month. This cost of their rent ($500 a month) would be considered a

fixed cost (they have to pay the $500 per month, regardless of how much pizza is produced).

The ingredients that it takes to make a pizza at Pieology Pizzeria cost $2 per pizza. Some months, Pieology Pizzeria may spend $6000 on ingredients. Some months, Pieoogy Pizzeria may spend $3000 on ingredients. This cost of ingredients is an example of a

variable cost (it varies with how many pizzas are produced that month).

In the long-run

all inputs can be varied.

Which of the following is a characteristic of a competitive market?

Buyers and sellers are price takers.

Why does a firm in a competitive industry charge the market price?

All of the above are correct.

Suppose a firm in a competitive market earned $1,000 in total revenue and had a marginal revenue of $10 for the last unit produced and sold. What is the average revenue per unit, and how many units were sold?

$10 and 100 units

In the short run, a firm operating in a competitive industry will shut down if price is

less than average variable cost.

When a restaurant stays open for lunch service even though few customers patronize the restaurant for lunch, which of the following principles is (are) best demonstrated?

(i) Fixed costs are sunk in the short run.

(ii) In the short run, only fixed costs are important to the decision to stay open for lunch.

(iii) If revenue exceeds variable cost, the restaurant owner is making a smart decision to remain open for lunch.

(i) and (iii) only

You purchase a $30, nonrefundable ticket to a play at a local theater. Ten minutes into the show you realize that it is not a very good show and place only a $10 value on seeing the remainder of the show. Alternatively you could leave the theater and go home and watch TV or read a book. You place an $8 value on watching TV and a $12 value on reading a book. Applying the principle of sunk costs, what should you do?

You should go home and read a book.

In the long run, a profit-maximizing firm will choose to exit a market when

total revenue is less than total cost.

The entry of new firms into a competitive market will

increase market supply and decrease market price.

Which of the following is not a characteristic of a monopoly?

one buyer

Which of the following is not an example of a barrier to entry?

An entrepreneur opens a popular new restaurant

The demand curve for a monopoly's product is

the market demand for the product.

A monopolist's profit-maximizing price and output correspond to the point on a graph

where marginal revenue equals marginal cost and charging the price on the market demand curve for that output.

𝑃𝑟𝑜𝑓𝑖𝑡

= 𝑇𝑅 ― 𝑇𝐶 = (𝑃 ― 𝐴𝑇𝐶) 𝑥 𝑄

𝑇𝑅 =

𝑃𝑥𝑄

𝑇𝐶 =

𝐹𝐶 + 𝑉𝐶 𝑎𝑛𝑑 _____= 𝐴𝑇𝐶𝑥𝑄

𝐴𝐹𝐶 =

𝐹𝐶

___

𝑄

𝐴𝑉𝐶 =

𝑉𝐶

___

𝑄

𝐴𝑇𝐶 =

𝑇𝐶

__

𝑄 𝑎𝑛𝑑 ____ = 𝐴𝐹𝐶 + 𝐴𝑉𝐶

𝑀𝐶 =

∆𝑇𝐶

___

∆𝑄

𝐴𝑅 =

𝑇𝑅

___

𝑄

𝑀𝑅 =

∆𝑇𝑅

___

∆𝑄

𝑀𝑃𝐿 =

∆𝑄

__

∆𝐿

Explicit vs. Implicit Costs:

________ require an actual payment, whereas ______ don’t. ________ usually

consist of foregone income (what you could have earned at another job), what you could

have earned from having money in a savings account, etc

Accounting profit =

the firm’s total revenue minus their explicit costs

Economic profit =

the firm’s total revenue minus ALL of their costs (explicit AND implicit).

Production Function:

When we do so, we are looking at varying one (or more) of the firm’s inputs and seeing how output varies in response.

Marginal Product (MP):

how does output change when we change one of the inputs by one unit?

Diminishing Marginal Product of Labor:

a firm displays this characteristic when an additional worker is actually less productive (contributes less to the total output) than the worker added before him (i.e. when the marginal product of labor decreases with an additional worker)

Marginal Cost (MC):

How do costs increase when we produce one more unit?

Fixed Cost (FC):

costs that do not change, and you have to pay, regardless of how much output you produce.

Variable Cost (VC)

Costs that change depending on how much output you produce.

Total Cost (TC)

The _______ of production is the sum of all of the firm’s fixed costs and all of their variable costs, put together

Average Fixed Cost (AFC)

The fixed cost per unit. It decreases as output increases.

Average Variable Cost (AVC)

The variable cost per unit. The ___ curve is typically U-shaped.

Average Total Cost (ATC)

The cost per unit. It incorporates both those fixed and variable costs. The ___ curve is typically U-shaped.

Efficient Scale

The quantity that makes the cost per unit (i.e. the ATC) as low as possible. This is the

quantity associated with the minimum point of that U-shaped ATC curve

Economies of Scale

A firm exhibits ________________ if increasing output makes the cost per unit decrease (i.e. makes ATC decrease)

Constant Returns to Scale

A firm exhibits ______________ if increasing output keeps the cost per unit the

same (i.e. ATC stays constant as Q increases)

Diseconomies of Scale

A firm exhibits _____________ if increasing output makes the cost per unit rise (i.e. makes ATC increase).

Perfect Competition:

this type of market has many firms where each firm is selling identical goods

– these two assumptions mean these firms are “price-takers” – i.e. they take the market price as given.

Average Revenue (AR):

the revenue per unit. This is (for ALL firms) just whatever the price is.

Marginal Revenue (MR):

how revenue changes when we sell one more unit. It is calculated as the change in total revenue, divided by the change in quantity.

Profit Maximization for a Competitive Firm:

For all firms, the maximum profit will occur at a quantity where MR=MC. If MR>MC, that means producing one more will make more in revenue than it will cost to produce it – so they should continue producing to make profit increase. If MR<MC, that means producing one more will cost more than the revenue they’d make off of it – so they should not produce that unit. For competitive firms find the quantity where

P=MR=MC

Shutdown:

a S-R decision to produce zero output, it will still have to pay its fixed costs. So: to decide whether a firm should ____ in the short run or not, a firm weighs its variable costs, If TR>VC, they should stay open in the S-R and produce the profit- maximizing level of output. Looking at this per unit, it means if P>AVC, they should stay open in the S-R and produce the profit-maximizing level of output. If TR<VC, they should _______ in the S-R and produce zero output. This ______ rule per unit is if P<AVC, they should ____ in the S-R and produce zero output

Exit:

a L-R decision to produce zero output. If a firm _____ the market, it has no costs to pay. A firm will _____ the market if they’re making negative economic profit/incurring losses. This would be the case if TR<TC. Per unit, this would mean that P<ATC. So a competitive firm will eventually ____ the market if P<ATC. A new firm will enter the market if current firms are earning profits (i.e. if TR>TC. Per unit, this would mean that P>ATC. So a new competitive firm will enter the market if P>ATC

Sunk Costs:

a cost that has already been paid for and cannot be recovered, so an economist says not to include a ______ in your future decisions. The fixed costs for a firm are _______ in the short run, so they only weigh their variable costs and their revenue in regards to shutting down.

Economic Profit

A firm earns positive _________ if their TR>TC. Per unit, that’s if P>ATC. If that’s occurring, new firms will enter that market in the long run.

Zero-Profit Condition:

A firm earns zero economic profit if their TR=TC

Monopoly:

a firm that is the only seller of a product without close substitutes

market power:

the ability to influence the market price of the produce it sells.

barriers to entry

when other firms cannot enter the market

3 sources of barriers to entry:

• A single firm owns a key resource

• The government gives a single firm the exclusive right to produce the good

(ex: patents & copyright laws)

• Natural monopoly: one firm can produce the market quantity at a lower cost than could several firms