Econ201 final

Chapter 11: Market Failure

  • Excludable: A good is excludable if it is possible to prevent people who have not paid for it from using it. (e.g., a bottle of water, a movie ticket)

  • Non-excludable: A good is non-excludable if it is impossible to prevent people who have not paid for it from using it. (e.g., national defense, public broadcasting)

  • Rival in Consumption: A good is rival in consumption if one person's use of the good diminishes another person's ability to use it. (e.g., a hamburger, a parking space)

  • Non-rival in Consumption: A good is non-rival in consumption if one person's use of the good does not diminish another person's ability to use it. (e.g., a public park, a digital download of a song)

Four Types of Goods:

  1. Private Goods: Excludable and Rival (e.g., food, clothing, cars)

  2. Public Goods: Non-excludable and Non-rival (e.g., national defense, streetlights)

  3. Common Resources: Rival and Non-excludable (e.g., fish in the ocean, clean air)

  4. Club Goods: Excludable and Non-rival (e.g., cable TV, a golf course)

  • Free-Rider Problem: Individuals have no incentive to pay for a public good because they can benefit from it without paying (they "free-ride" on the contributions of others).

    • Public goods suffer from the free-rider problem.

  • Tragedy of the Commons: When a common resource is overused because individuals act in their own self-interest, leading to depletion of the resource.

    • Common resources suffer from the tragedy of the commons.

  • Why Private Markets Fail:

    • Public Goods: Private firms cannot prevent non-payers from using the good, so they have no incentive to produce it.

    • Common Resources: Individuals have an incentive to overuse the resource, leading to its depletion.

Chapter 14: Production Costs

  • Profits: The difference between total revenue and total cost.

    • Profit = Total Revenue - Total Cost

    • Profits are the primary goal of most businesses.

  • Costs: The resources used to produce a good or service.

    • Explicit Costs: Direct, out-of-pocket payments for inputs (e.g., wages, rent, materials).

    • Implicit Costs: The opportunity cost of using the firm's own resources (e.g., the forgone income from using the owner's own money instead of investing it elsewhere).

  • Accounting Profit: Total Revenue - Explicit Costs

  • Economic Profit: Total Revenue - (Explicit Costs + Implicit Costs)

  • Production Function: Shows the relationship between the quantity of inputs used and the quantity of output produced.

    • Inputs: Resources used in production (e.g., labor, capital, land).

    • Marginal Product: The increase in output that results from a one-unit increase in input.

    • Diminishing Marginal Product: The principle that as more and more of a variable input is added to a fixed input, the marginal product of the variable input eventually declines.1

  • Variable Costs: Costs that vary with the quantity of output produced (e.g., wages for workers, cost of raw materials).

  • Fixed Costs: Costs that do not vary with the quantity of output produced (e.g., rent, insurance).

    • Total Cost = Variable Costs + Fixed Costs

  • AVC (Average Variable Cost): Variable Cost / Quantity of Output

  • AFC (Average Fixed Cost): Fixed Cost / Quantity of Output

  • Marginal Cost (MC): The increase in total cost from producing one more unit of output.

    • MC is related to ATC and AVC: When MC is below ATC, ATC is falling. When MC is above ATC, ATC is rising. MC intersects ATC at its minimum point.

  • Economies of Scale: As output increases, the average cost of production decreases. (Long Run)

  • Diseconomies of Scale: As output increases, the average cost of production increases. (Long Run)

  • Constant Returns to Scale: As output increases, the average cost of production remains constant. (Long Run)

Chapter 15: Perfect Competition

  • Characteristics of Perfectly Competitive Firms:

    • Many buyers and sellers

    • Identical products

    • Free entry and exit

    • Price takers (firms have no control over the market price)

    • Examples: Agriculture (e.g., wheat, corn), foreign exchange markets

  • Price Taker: A firm that must accept the market price for its product.

  • Marginal Revenue (MR): The change in total revenue from selling one more unit of output.

  • Demand Curve: For a perfectly competitive firm, the demand curve is horizontal (perfectly elastic) at the market price.

  • Supply Curve:

    • Short Run: The firm's supply curve is the portion of the marginal cost curve that lies above the average variable cost curve.

    • Long Run: In the long run, firms can enter or exit the market. If existing firms are making economic profits, new firms will enter, increasing supply and driving down the price. If existing firms are incurring economic losses, some firms will exit, decreasing supply and driving up the price.

  • Profit Maximizing Rule:

    • Produce where Marginal Revenue (MR) equals Marginal Cost (MC): MR = MC

      • If MR > MC, the firm should increase output.

      • If MC > MR, the firm should decrease output.

  • Short Run Shutdown Decision:

    • If P > ATC, the firm is making a profit.

    • If ATC > P > AVC, the firm is making a loss, but it should continue to produce in the short run to minimize its losses.

    • If AVC > P, the firm should shut down immediately.

  • Long Run: In the long run, if firms are making economic losses, they will exit the market. In the long run, perfectly competitive firms earn zero economic profit.

  • Sunk Costs: Costs that have already been incurred and cannot be recovered. Sunk costs should not be considered in the decision to shut down or continue production.

Chapter 16: Monopoly

  • Characteristics of Monopoly Firms:

    • One seller

    • Unique product

    • Significant barriers to entry (e.g., government regulations, control of key resources)

    • Examples: Public utilities (e.g., water, electricity), copyright holders

  • Price Maker: A firm that can influence the market price of its product.

  • Barriers to Entry: Obstacles that prevent new firms from entering a market.

  • Comparison of Competitive Market to Monopoly:

    • Similarities: Both seek to maximize profits.

    • Differences:

      • Competitive Market: Price taker, demand curve is perfectly elastic, earns zero economic profit in the long run.

      • Monopoly: Price maker, demand curve is downward sloping, can earn economic profit in the long run.

  • Long Run Economic Profit: Monopolies can earn economic profit in the long run due to barriers to entry.