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1

production is

converting inputs into outputs

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2

firms must make ---- to earn profit

products (output)

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3

inputs are the ---- used to make outputs

resources

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4

input resources are also called

factors

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5

total physical product is

the total output or quantity produced

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marginal product is

the additional output generated by additional inputs (workers)

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marginal product formula

change in total product divided by change in input

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average product

total product divided by units of labor

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fixed resources

resources that don’t change with the quantity produced

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variable resources

resources that do change with the quantity produced

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law of diminishing marginal returns

as variable resources are added to fixed resources, the additional output produced per additional worker will decrease

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three stages of return

increasing marginal returns

decreasing marginal returns

negative marginal returns

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13

increasing marginal returns

marginal product is rising and total product is increasing at an increasing rate due to specialization

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decreasing marginal returns

marginal product is falling and total product is increasing at a decreasing rate because of fixed resources (each worker adds less and less)

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negative marginal returns

marginal product is negative and total product is decreasing because workers get in each others way

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short run

at least one resource is fixed, production capacity is fixed

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long run

all resources are variable, no fixed resources, production capacity is changeable

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total costs

total fixed cost, total variable cost, total cost

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per unit costs

average fixed costs, average variable costs, average total costs, marginal cost

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fixed cost

cost for fixed resources that don’t change with the amount produced

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average fixed cost (AFC) formula

fixed cost divided by quantity

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variable cost

cost for variable resources that do change as more or less is produced

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average variable cost (AVC) formula

variable cost divided by quantity

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24

total cost

sum of fixed and variable costs

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25

average total cost formula

total costs divided by quantity

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marginal cost

additional cost of an additional output

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marginal cost formula

change in total costs divided by change in quantity

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28

ATC and AVC curves will

get closer but never touch

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marginal product curve reasoning

more workers are hired → marginal product increases → law of diminishing marginal returns → marginal product decreases

MP and MC are mirror images

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marginal cost curve reasoning

marginal cost of units produced decreases as marginal product increases, eventually increases due to diminishing marginal returns

MP and MC are mirror images

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ATC shape reasoning

when MC is below average, it pulls ATC down and when MC is above average, it pulls ATC up, and this creates bowl curve

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MC intersects the ATC at

the ATC’s lowest point

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returns to scale

increasing

constant

decreasing

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increasing returns to scale

when doubling input, output more than doubles

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constant returns to scale

when doubling input, output doubles

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decreasing returns to scale

when doubling input, output less than doubles

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37

long run ATC curve is made up of

all the different short run ATC curves

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why do economies of scale occur

firms that produce more can better use mass production techniques and specialization

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LRATC - economies of scale

mass production techniques are used so LRATC falls

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LRATC - constant returns to scale

LRATC is as low as it can get

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LRATC - diseconomies of scale

LRATC increases as firm gets too big and difficult to manage

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LRATC graph

downward slope → economies

constant slope → constant

upward slope → diseconomies

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diminishing marginal returns don’t apply in the long run because

there are no fixed resources

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total revenue formula

price x quantity

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profit formula

total revenue - total cost

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explicit costs

payments made by firms for using the resources of others, AKA out of pocket costs

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implicit costs

opportunity costs that firms pay for using their own resources

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accounting profit

total revenue - accounting costs

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economic profit

total revenue - economic costs

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profit maximizing rule

MR = MC

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shut down rule

firms should continue to produce as long as price is above AVC

if price is below AVC, minimize loss by shutting down bc loss is bigger than fixed coss

shut down if P < AVC

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marginal cost and supply

price increases → quantity increases

price decreases → quantity decreases

MC increase → supply decrease

MC decrease → supply increase

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MC above AVC is a ---- supply cirve

short run

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barriers to entry

factors that prevent new firms from entering a given market

low barriers → more competition → less profit per firm

high barriers → less competition → more profit per firm

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normal profit

no economic profit

in an efficient competitive market, firms with identical products make a normal profit

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four market structures

perfect competition

monopolistic competition

oligopoly

monopoly

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imperfect competition markets

monopolistic competition

oligopoly

monopoly

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perfect competition characteristics

many small firms

identical products (perfect substitutes)

low barriers

seller has no need to advertise

price takers → no control over price

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types of barriers to entry

economies of scale

only one electric company because they can make electricity at lowest cost

natural monopoly

superior technology

geography/ownership of raw materials

government created barriers

patents

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monopoly characteristics

one large firm

unique product (no close substitutes)

high barriers

monopolies are price makers

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oligopoly characteristics

a few (less than 10) large producers

identical or differentiated products

high barriers to entry

price maker

mutual interdependence

firms worry about decisions of competitors and use strategy

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monopolistic competition characteristics

relatively large number of sellers

differentiated products

some control over prices

low barriers

non-price competition (advertising)

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why perfectly competitive firms are price takers

charge above market price → nobody will buy

charge below market price → not necessary because demand stays the same

price is the same at all quantities demanded

demand curve is perfectly elastic

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price taker means

price is set by the industry

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for perfect competition, MR =

MR = D = AR = P

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for perfect competition, the demand curve is

industry → downward sloping line

firm → horizontal line

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perfect competition firm profit

MC = MR intersection down to ATC

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characteristics of MR = MC

applies to all markets

only applies of P > AVC

can be restated as P = MC for perfectly competitive firms

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per unit tax is an example of a ---- increase

variable cost

causes supply to decrease

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subsidy is an example of a ---- decrease

variable cost

causes supply to increase

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if fixed cost increase, quantity will

remain the same because MC/supply doesn’t change

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per unit tax ---- affect the quantity produced

will

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lump sum tax ---- affect the quantity produced

will not

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change in fixed cost changes

ATC and AFC but not MC

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change in variable cost changes

ATC, AVC, and MC

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perfect competition in the long run

profit → firms enter

loss → firms leave

all firms break even (make no economic profit)

no economic profit = normal profit

extremely efficient

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no economic profit is the same as ---- accounting profit

positive

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change in number of firms impacts market supply by

firms leave → price increases → quantity decreases

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constant cost industry

entry of new firms into the market does not increase the costs for firms already in the market

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in a constant cost industry, supply curve is

horizontal

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in an increasing cost industry, the supply curve is

upward sloping

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productively efficiency

producing at the lowest possible cost (P = min ATC)

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allocative efficiency

producing at the amount most desired by society (P = MC)

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long run perfectly competitive firm efficiency

allocative and productive

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short run perfectly competitive firm efficiency

allocative but not productive

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