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MicroEconomics
Final Exam Study Guide
163
Economics
Undergraduate 2
12/12/2010

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Term
Comparative Advantage
Definition
the ability to produce a good at a lower opportunity cost than another producer
Term
A person can have the comparative advantage in how many goods?
Definition
Zero or One
Term
Absolute Advantage
Definition
The ability to produce a good using fewer inputs than another producer
Term
A person may have the absolute advantage in how many goods?
Definition
Zero, One, Two
Term
Opportunity Cost
Definition
What must be given up to obtain some item
Term
How to calculate opportunity cost
Definition
Loss/Gain
Term
Characteristics of Competitive Markets
Definition
Large number of buyers and sellers
No buyer or seller has control (price takers)
Good are identical
All goods are private
Term
Law of Demand
Definition
An increase in price will reduce the quantity demanded
Term
Law of Supply
Definition
In increase in price will increase the quantity supplied
Term
Factors that shift Supply
Definition
Input prices, Technology, Expectations, Number of sellers
Term
Factors that shift Demand
Definition
Income, Prices of substitutes or compliments, Tastes, expectations, number of buyers
Term
Elasticity of Demand
Definition
Measures how much the quantity demanded responds to a change in price; how willing consumers are to buy less of a good as the price of that good rises
Term
Elasticity of Supply
Definition
measures how much the quantity supplied responds to changes in price; depends on the flexibility of sellers to change the amount of the good they produce
Term
Is supply normally elastic or inelastic in the long run?
Definition
Elastic
Term
Income Elasticity of Demand
Definition
a measure of how much the quantity demanded of a good responds to a change in a consumers income
Term
What is the formula for Income Elasticity?
Definition
% change in QD/ % change in income
Term
What is the IE of a necessity?
Definition
Between 0 and 1
Term
What is the IE of a luxury?
Definition
>1
Term
Cross Price elasticity
Definition
Measures how much the quantity demanded of a good responds to a change in the price of another good
Term
If CPE is negative, the goods are ________.
Definition
Compliments
Term
If CPE is positive, the goods are ______.
Definition
Substitutes
Term
How to calculate CPE
Definition
% change in QD of good 1/ % change in price of good 2
Term
If demand is elastic, TR _________
Definition
decreases
Term
If demand is inelastic, TR _______
Definition
increases
Term
Perfectly Elastic
Definition
E = infinity
Term
Elastic
Definition
E > 1
Term
Unit Elastic
Definition
E=1
Term
Inelastic
Definition
E < 1
Term
Perfectly Inelastic
Definition
E=0
Term
The more specific something is the more _______ it will be.
Definition
Elastic
Term
The more substitutes something has the more ________ it will be.
Definition
elastic
Term
What happens to consumer surplus when price increases?
Definition
CS decreases
Term
What happens to producer surplus when price increases?
Definition
PS increases
Term
Marginal Seller
Definition
the seller who would leave the market if prices were any lower
Term
Marginal Buyer
Definition
the buyer who would leave the market is the price were any higher
Term
If demand shifts, you are unsure about _________.
Definition
CS
Term
If supply shifts, you are unsure about ________
Definition
PS
Term
Efficiency
Definition
is the property of a resource allocation of maximizing the total surplus received by all members of society
Term
Equity
Definition
is the fairness of the distribution of well being among various buyers and sellers
Term
Explicit Costs
Definition
Things that are explicitly purchased
Term
Implicit Costs
Definition
Opportunity Costs
Term
Economic Profit
Definition
TR - All costs
Term
Accounting Profit
Definition
TR - Explicit Costs only
Term
What if Economic Profit is negative?
Definition
You're not doing as well as you could be and you should go with your other alternative
Term
Production Function
Definition
Tells us the output the firm gets when they use a certain amount of capital and labor
Term
Inputs in the short run and long run
Definition
SR - at least input is fixed
LR - all are variable
Term
MPL
Definition
the increase in quantity when one more worker is hired
Term
Diminishing marginal product
Definition
the point where MPL is no longer increasing, but actually decreasing
Term
AFC
Definition
FC/Q
Term
Fixed Costs are...
Definition
Costs that do not change with quantity; cost where Q = 0
Term
Variable costs are
Definition
costs that do change with quantity; ex. labor
Term
AVC
Definition
VC/Q
Term
Total Cost
Definition
FC + VC
Term
ATC
Definition
TC/Q
Term
Economies of Scale
Definition
LR ATC falls as production increases; input < output
Term
Diseconomies of Scale
Definition
LR ATC rises as production increases; input > output
Term
Constant Returns to Scale
Definition
LR ATC stays the same as production increases; input = output
Term
Characteristics of Competitive Markets
Definition
many firms/many buyers
identical products
no barriers to entry
everyone is well informed
Term
How is price determined for firms in a competitive market?
Definition
The market sets the price at the intersection of S and D, and the firm follows.
Term
In a competitive market, price is....
Definition
equal to demand and is perfectly elastic (horizontal line)
Term
In the long run, perfect competition will produce where?
Definition
at the lowest point of the ATC curve
Term
If D > AVC, should the firm stay open or shut down?
Definition
Stay open
Term
If D < ATC, should the firm stay open or shut down?
Definition
Shut down and exit in the LR
Term
Single Price Monopoly
Definition
Limit supply and charge a high price for their goods
Term
Characteristics of Single Price Monopoly
Definition
Barriers to entry - earning them LR profits
No close substitutes
Controls a scarce resource
Term
Where is Q set in a single price monopoly?
Definition
where MR = MC
Term
Where is P set in a single price monopoly?
Definition
where Q intersects D
Term
What is a natural monopoly?
Definition
when one firm can provide a service for a lower cost than two firms
Term
Deadweight Loss
Definition
the amount of surplus lost because of underproduction; inefficiency
Term
If P > MC = MR, what kind of market are we talking about?
Definition
Single Price Monopoly
Term
Price Discrimination
Definition
when a firm charges different groups of customers different prices for the same good or service
Term
Perfect Price discrimination
Definition
when the firm knows each individuals WTP and charges them that amount
Term
Characteristic of Monopolistic Competition
Definition
Lots of firms
No barriers to entry
Differentiated product
downward sloping D curve
Term
Where is Q set in a monopolistic competition market?
Definition
where MR = MC
Term
Where is P set in a monopolistic competition market?
Definition
Where Q intersects D & ATC
Term
What is the difference in the long run equilibrium for perfectly competitive markets and monopolistic competitive markets?
Definition
Perfect - produces at the minimum point of ATC
Monopolistic - does not produce at minimum point of ATC
Term
The Product Variety Externality
Definition
positive externality in a monopolistically competitive market; consumers acquire surplus when a new product is introduced
Term
The Business-Stealing Externality
Definition
a negative externality in a monopolistically competitive market; firms lose customers and profit when a new competitor enters the market
Term
Advertising in a monopolistically competitive market
Definition
Can delay NOT prevent a firm from shutting down/exiting the market
Term
Characteristics of Oligopoly
Definition
Few firms
Medium Barriers to entry
Term
Cartels
Definition
multiple oligopolies acting together as a monopoly to maximize profits (reduces total surplus)
Term
Nash equilibrium
Definition
no player can make himself better off by changing only his own action; where there are two circles in the same square
Term
Non-dominant Strategy
Definition
a player will change his decision based on the other person's decisions
Term
Dominant Strategy
Definition
A player will do the same thing and be better off regardless of the actions of the rival
Term
Prisoner's Dilemma
Definition
Each players has a dominant strategy
There is a single equilibrium
Both players are worse off in the equilibrium
conflict between individual gain and group gain
Term
Production Function Inputs
Definition
Capital and Labor
Term
Derived Demand
Definition
a firm's demand for a factor of production is derived from its decision to supply a good in another market
Term
As VMPL increases, the demand for that input ______
Definition
increases
Term
VMPL = ________
Definition
P * MPL
Term
If price increases, Demand (VMPL) _______
Definition
increases
Term
Competitive Profit Maximizing Firms:
Definition
maximize profits where VMPL = equilibrium market wage
Term
Factor that shift Labor Demand
Definition
output price, technology, supply of other factors
Term
Factors that shift labor supply
Definition
changes in tastes, changes in alternative opportunities,
immigration
Term
The market for land is _______
Definition
very inelastic
Term
The market for capital is ________
Definition
very elastic
Term
Assume that Greece has a comparative advantage in fish and Germany has a comparative advantage in cars. Also assume Germany has an absolute advantage in both fish and cars. If these two countries specialize and trade, then....
Definition
Germany will produce more cars than it would produce in the absence of trade
The two countries combined output of both goods will be higher than it would be in the absence of trade
Greece will produce more fish than it would produce in the absence of trade
Term
Suppose an economy produces food and machines and it always operates ON the ppf. Last year it produced 50 units of food and 30 machines. This year is produced 55 units of food and 33 machines. Which of the following could NOT explain the increase in output: an improvement in technology, an increase in available labor, reduction in unemployment.
Definition
A reduction in unemployment
Term
If for two goods, the cross-price elasticity of demand is 1.25, then the two goods are _________
Definition
substitutes
Term
When demand is inelastic, a decrease in price will cause....
Definition
a decrease in total revenue
Term
Suppose demand is perfectly elastic, and the supply of the good in question decreases. As a result....
Definition
the equilibrium quantity decreases, and the equilibrium price is unchanged
Term
Computers and printer are compliments. An increase in the price of computers will cause....
Definition
a decrease in the demand for printers and a decrease in the quantity supplied of printers
Term
In the long run, the quantity supplied of most goods can/cannot respond substantially to a change in price?
Definition
CAN
Term
If the wage of current workers a a bicycle plant increase by a dollar, then it is likely that....
Definition
the supply of bicycles will shift to the left
Term
Assume that a 4% increase in income results in a 2% increase in the qty demanded of a good. The IE of demand for the good is....
Definition
positive and therefore the good is a normal good
Term
Absolute advantage is found by comparing different producers' ______________
Definition
input requirements per unit of output
Term
Two goods are substitutes when a decrease in the price of one good....
Definition
decreases the qty demanded of another good
Term
"When the price of a good decreases, buyers purchase more of the good"....is a good representation of what?
Definition
Law of Demand
Term
What would happen to the equilibrium price and qty of peanut butter is the price of peanuts went up, the price of jelly fell, fewer firms decided to produce peanut butter, and health officials announced that eating peanut butter was good for you?
Definition
Price will rise and the effect on quantity is ambiguous..
Term
A market demand curve shows...
Definition
how much of a good all buyers are willing and able to buy at each possible price.
Term
A market where there are so many buyers and so many sellers that each has a negligible impact on the price of the product is what kind of market?
Definition
Competitive
Term
The opportunity cost of obtaining more of one good is shown on the PPF as the ...
Definition
amount of the other good that must be given up
Term
If an economy is producing efficiently, on the PPF, then...
Definition
there is no way to produce more of one good without producing less of another good
Term
The demand for Neapolitan ice cream is likely quite elastic because...
Definition
other flavors of ice cream are good substitutes for this particular flavor
Term
For a particular good, a 12% increase in price causes a 3% decrease in qty demanded. What does this IE tell us?
Definition
This good is a necessity
Term
If Francis experiences a decrease in his income, then we would expect Francis's demand for...
Definition
normal goods to decrease, and dmd for inferior goods to increase
Term
If the price elasticity of supply for a good is equal to infinity, then....
Definition
the supply curve is horizontal
Term
A supply curve slopes upward because...
Definition
an increase in price gives producers an incentive to supply a larger quantity
Term
When consumers face rising gasoline prices, they typically....
Definition
reduce their qty demanded more in the LR than in the SR
Term
The flatter the D curve through a given point, the...
Definition
greater the price elasticity of demand at that point
Term
The particular price that results in QS being equal to QD is the best price because...
Definition
it maximizes the combined welfare of buyers and sellers
Term
In a market, the marginal buyer is the buyer...
Definition
who would be the first to leave the market if prices were any higher
Term
Diminishing marginal product suggests that the marginal...
Definition
product of an extra worker is less than the previous worker's marginal product
Term
The efficient scale of the firm is the qty of output that..
Definition
minimizes average total cost
Term
Which is an example of an implicit cost:
salaries paid to owners who work for the firm
interest on money borrow to finance purchases
foregone rent on office space owned/used by firm
cash payments for raw materials
Definition
foregone rent on office space owned/used by firm
Term
Which of the following will cause an increase in producer surplus:
the price of a sub. increases
buyers expect the price of the good to be lower next month
income increases and buyers consider the good to be inferior
the imposition of a binding price ceiling in the mkt
Definition
the price of a substitute increases
Term
A drought in California destroys many red grapes. As a result of the drought, the consumer surplus in the market for red grapes...
Definition
decreases, and the consumer surplus for red wine decreases
Term
When marginal cost is less than ATC...
Definition
ATC is falling
Term
Efficiency in a market is achieved when...
Definition
the sum of producer surplus and consumer surplus are maximized
Term
Willingness to pay measures...
Definition
the value that a buyer places on a good
Term
If a consumer places a value of $15 on a good and the selling price is $17, will he purchase the good?
Definition
NO
Term
Economies of scale occur when a firm's...
Definition
long run ATC are decreasing as output increases
Term
Total surplus is represented by the area below the...
Definition
demand curve and above the supply curve up to the equilibrium qty
Term
Marginal cost equals...
Definition
change in total cost/change in qty produced &
change in variable cost/change in qty produced
Term
Economists normally assume that the goal of a firm is to...
Definition
maximize profit
Term
A natural monopoly occurs when...
Definition
there are economies of scale over the relevant range of output
Term
What happens when the prisoner's dilemma is repeated numerous times in an oligopoly market?
Definition
The firms may well reach the monopoly outcome.
Buyers of the oligopolists' product will likely be worse off as a result.
Term
The profit maximization problem for a monopolist differs from that of a competitive firm in which way?
Definition
A competitive firm maximizes profit at the point where AVG Revenue equals MC; a monopolist maximizes profit at the point where AVG Revenue exceeds MC
Term
Each firm in a monopolistically competitive firm faces a downward sloping demand curve because....
Definition
the firm's product is different from those offered by other firms in the market.
Term
A firm's marginal cost has a minimum value of $2, AVC of $4, and ATC of $5. The firm will shut down if the price of its product falls below what price?
Definition
$4
Term
For a profit-maximizing monopolistically competitive firm, price exceeds MC in...
Definition
the SR and LR
Term
The DWL associated with a monopoly occurs because the monopolist...
Definition
produces an output less then the socially optimal level
Term
In the LR both monopolistically competitive and perfectly competitive firms produce where P = ATC or where P = MC?
Definition
Where P = ATC
Term
What do the output and price effects have on a monopoly's revenue when it increases its output and sales?
Definition
The output effect works to increase TR, and the price effect works to decrease TR
Term
If firms in a monopolistically competitive market are earning economic profits, what is a change they should expect to see as the market adjusts to the long-run equilibrium?
Definition
A decrease in demand for each firm
Term
A monopolistically competitive firm:
Definition
experiences a zero profit in a long-run equilibrium
is said to have excess capacity
has the usual DWL of monopoly pricing
Term
3 Rules of Profit Maximization Decisions
Definition
1) If MR < MC, the firm should decrease its output
2) If MR = MC the firm should continue producing its current level of output
3) If MR > MC, the firm should increase its output
Term
A monopolistically competitive industry is characterized by...
Definition
many firms selling products that are similar but not identical.
Term
For all competitive firms...
Definition
Average Revenue = Price of the good
Term
What are necessary characteristics of a monopoly?
Definition
The firm is the sole seller of its product.

The firm's product does not have close substitutes
Term
The textile industry is composed of a large number of small firms. In recent years, these firms have suffered economic losses and many sellers have left the industry. Economic theory suggests that these conditions will....
Definition
cause the market supply to decline and the price of textiles to rise.
Term
Resale Price Maintenance is...
Definition
when a firm requires that a firm reselling its product do so at a specific price
Term
To move the allocation of resources closer to the social optimum, policy makers should typically try to induce firms in an oligopoly to...
Definition
compete rather then cooperate with each other.
Term
A firm in a monopolistically competitive market is similar to a monopoly is which ways?
Definition
1) they both face downward sloping demand curves
2) they both charge a price that exceeds marginal cost
Term
In a competitive market, no single producer can influence the market price because...
Definition
many other sellers are offering a product that is essentially identical
Term
Assuming that oligopolists do not have the opportunity to collude, once they have reached the Nash Equilibrium, it always in their best interest to...
Definition
leave their quantities supplied unchanged
Term
A distinguishing feature of an oligopolistic industry is the tension between...
Definition
cooperation and self-interest
Term
When oligopolies collude, they are behaving as _______
Definition
a cartel
Term
For a competitive firm..
Definition
Average Revenue = Marginal Revenue
Term
If the monopolist's marginal revenue is greater than its marginal cost, the monopolist can increase profit by...
Definition
selling more units at a lower price per unit
Term
As new firms enter a monopolistically competitive market, profits of existing firms...
Definition
decline, and product diversity in the market increases
Term
The demand curve facing a competitive firm is _______, whereas the demand curve facing a monopolist is ________.
Definition
horizontal; downward sloping
Term
The equilibrium quantity in markets characterized by oligopoly is...
Definition
higher than in monopoly markets and lower than in perfectly competitive markets
Term
Critics of advertising argue that in some markets advertising may...
Definition
decrease elasticity of demand allowing firms to charge a lower markup over marginal cost
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