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Microeconomics Test 2
Microeconomics Test 2
205
Economics
06/24/2016

Term
 the firm's goal
Definition
 we assume this is to maximize profit
Term
 equation for profit
Definition
 Profit = Total revenue – Total cost
Term
 total revenue
Definition
 the amount a firm receives from the sale of its output
Term
 total cost
Definition
 the market value of the inputs a firm uses in production
Term
 Explicit costs
Definition
 require an outlay of money, e.g., paying wages to workers
Term
 Implicit costs
Definition
 do not require a cash outlay, e.g., the opportunity cost of the owner’s time
Term
 Accounting profit
Definition
 total revenue minus total explicit costs
Term
 Economic profit
Definition
 total revenue minus total costs (including explicit and implicit costs)
Term
 why accounting profit is higher than economic profit
Definition
 because it ignores implicit costs
Term
 production function
Definition
 -shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good-It can be represented by a table, equation, or graph
Term
 marginal product
Definition
 The marginal product of any input is the increase in output arising from an additional unit of that input, holding all other inputs constant.
Term
 equation for Marginal product of labor (MPL)
Definition
 Marginal product of labor (MPL)=(∆Q/∆L)∆Q = change in output, ∆L = change in labor
Term
 Diminishing marginal product
Definition
 The marginal product of an input declines as the quantity of the input increases (other things equal).
Term
 Marginal Cost (MC)
Definition
 the increase in Total Cost from producing one more unit
Term
 equation for marginal cost (MC)
Definition
 MC=(∆TC/∆Q)TC= total cost and Q= quantity
Term
 Fixed costs (FC)
Definition
 do not vary with the quantity of output produced.
Term
 Variable costs (VC)
Definition
 vary with the quantity produced.
Term
 equation for Total cost (TC)
Definition
 TC = FC + VCTC= total cost, FC= fixed cost, VC= variable cost
Term
 Average total cost (ATC)
Definition
 equals total cost divided by the quantity of output: ATC = TC/QAlso, ATC = AFC + AVC
Term
 Why ATC Is Usually U-Shaped
Definition
 As Q rises:Initially, falling AFC pulls ATC down.Eventually, rising AVC pulls ATC up.
Term
 Efficient scale
Definition
 The quantity that minimizes ATC.
Term
 When MC < ATC,...
Definition
 ATC is falling
Term
 When MC > ATC,...
Definition
 ATC is rising
Term
 where the MC curve and the ATC curve cross
Definition
 at the ATC curve’s minimum
Term
 costs in the short run
Definition
 Some inputs are fixed (e.g., factories, land). The costs of these inputs are FC.
Term
 costs in the long run
Definition
 All inputs are variable (e.g., firms can build more factories or sell existing ones).
Term
 In the long run, ATC at any Q is...
Definition
 cost per unit using the most efficient mix of inputs for that Q (e.g., the factory size with the lowest ATC).
Term
 long run ATC (LRATC) as it relates to factory size
Definition
 [image]
Term
 the composition of a typical LRATC curve
Definition
 the combined effect of many SRATC's, as demonstrated here[image]
Term
 Economies of scale
Definition
 -ATC falls as Q increases-occur when increasing production allows greater specialization-more common when Q is low
Term
 Constant returns to scale
Definition
 ATC stays the same as Q increases
Term
 Diseconomies of scale
Definition
 -ATC rises as Q increases-these are due to coordination problems in large organizations-More common when Q is high
Term
 marginal product of labor
Definition
 the increase in output from a one-unit increase in labor, holding other inputs constant
Term
 Characteristics of Perfect Competition
Definition
 1. Many buyers and many sellers.2. The goods offered for sale are largely the same.3. Firms can freely enter or exit the market.
Term
 why both the buyer and the seller are "price takers"
Definition
 1. Many buyers and many sellers.2. The goods offered for sale are largely the same.
Term
 equation for total revenue
Definition
 TR = P x Q
Term
 equation for average revenue (AR)
Definition
 AR = (TR/Q) = P
Term
 marginal revenue (MR)
Definition
 The change in TR from selling one more unit
Term
 equation for marginal revenue
Definition
 MR = (∆TR/∆Q)
Term
 MR = P is only true for...
Definition
 firms in competitive markets.
Term
 If Q increases by one unit, what happens to revenue and cost?
Definition
 revenue rises by MR and cost rises by MC
Term
 If MR > MC,...
Definition
 increase Q to raise profit
Term
 If MR < MC,...
Definition
 reduce Q to raise profit
Term
 a Firm’s Supply Decision at MC < MR
Definition
 increase Q to raise profit
Term
 a Firm’s Supply Decision at MC > MR
Definition
 reduce Q to raise profit
Term
 a Firm’s Supply Decision at MC = MR
Definition
 Changing Q would lower profit
Term
 a competitive firm's profit maximizing Q
Definition
 the Q at which MR = MC
Term
 MR = MC at this Q
Definition
 profit maximizing Q
Term
 change in price vs. change in profit maximizing quantity
Definition
 when price rises, profit maximizing quantity rises
Term
 this determines the firm’s Q at any price
Definition
 the MC curve
Term
 this is a firm's supply curve
Definition
 the MC curve
Term
 Shutdown
Definition
 A short-run decision not to produce anything because of market conditions
Term
 Exit
Definition
 A long-run decision to leave the market
Term
 a key difference between shutdown and exit
Definition
 -If shut down in SR, must still pay FC.-If exit in LR, zero costs.
Term
 a firm's cost of shutting down
Definition
 revenue loss = TR
Term
 firm's benefit of shutting down
Definition
 cost savings = VC (variable costs)firm still has to pay FC (fixed costs)
Term
 firm shuts down when...
Definition
 TR < VCtranslates to P < AVC
Term
 The firm’s SR supply curve is...
Definition
 the portion of its MC curve above AVC.
Term
 what firm does if P > AVC
Definition
 produce Q where P = MC
Term
 what firm does if P < AVC
Definition
 produces Q = 0
Term
 Sunk cost
Definition
 a cost that has already been committed and cannot be recovered
Term
 why sunk costs should be irrelevant to decisions
Definition
 you must pay them regardless of your choice
Term
 example of sunk cost
Definition
 fixed costs (FC)
Term
 Cost of exiting the market
Definition
 revenue loss = TR
Term
 Benefit of exiting the market
Definition
 cost savings = TC(zero FC in the long run)
Term
 firm exits when
Definition
 TR < TCtranslates to P < ATC
Term
 a new firm will enter the market if...
Definition
 TR > TCtranslates to P > ATC
Term
 the competitive firm's supply curve
Definition
 the portion of its MC curve above LRATC
Term
 equation for profit per unit
Definition
 Profit per unit = P – ATC
Term
 equation for a firm's total loss
Definition
 Total loss = (ATC – P) x Q
Term
 some market supply assumptions
Definition
 1) All existing firms and potential entrants have identical costs.2) Each firm’s costs do not change as other firms enter or exit the market.3) The number of firms in the market is -fixed in the short run (due to fixed costs)-variable in the long run (due to free entry and exit)
Term
 when each form produces its profit maximizing quantity
Definition
 when P ≥ AVC
Term
 If existing firms earn positive economic profit,...
Definition
 -new firms enter, SR market supply shifts right. -P falls, reducing profits and slowing entry.
Term
 If existing firms incur losses,...
Definition
 -some firms exit, SR market supply shifts left. -P rises, reducing remaining firms’ losses.
Term
 Long-run equilibrium
Definition
 The process of entry or exit is complete— remaining firms earn zero economic profit.
Term
 Zero economic profit occurs when...
Definition
 P = ATC
Term
 the zero-profit condition is...
Definition
 P = MC = ATC
Term
 in the long run, P = ...
Definition
 minimum ATC
Term
 Why Do Firms Stay in Business if Profit = 0?
Definition
 because economic profit is revenue minus all costs
Term
 In the zero-profit equilibrium, this happens regarding firms and accounting profit.
Definition
 -firms earn enough revenue to cover these costs-accounting profit is positive
Term
 In the long run, the typical firm earns this much profit.
Definition
 0
Term
 what the LR market supply curve looks like
Definition
 The LR market supply curve is horizontal at P = minimum ATC.
Term
 The LR market supply curve is horizontal if...
Definition
 1) all firms have identical costs, and2) costs do not change as other firms enter or exit the market.
Term
 Why the LR Supply Curve Might Slope Upward
Definition
 If either1) Firms Have Different Costs2) Costs Rise as Firms Enter the Market
Term
 the equilibria of a competitive market
Definition
 -Profit-maximization: MC = MR-Perfect competition: P = MR-So, in the competitive eq’m: P = MC
Term
 the equilibria of a firm in a perfectly competitive market
Definition
 price = marginal revenue = average revenue
Term
 If P > AVC,...
Definition
 a firm maximizes profit by producing the quantity where MR = MC
Term
 If P < ATC,...
Definition
 a firm will exit in the long run
Term
 monopoly
Definition
 a firm that is the sole seller of a product without close substitutes.
Term
 the key difference between monopoly and perfect competition
Definition
 A monopoly firm has market power, the ability to influence the market price of the product it sells. A competitive firm has no market power.
Term
 the main cause of monopolies
Definition
 barriers to entryother firms can't enter the market
Term
 3 sources of barriers to entry
Definition
 1. A single firm owns a key resource.E.g., DeBeers owns most of the world’s diamond mines2. The govt gives a single firm the exclusive right to produce the good.E.g., patents, copyright laws3. Natural monopoly: a single firm can produce the entire market Q at lower cost than could several firms.
Term
 Natural monopoly
Definition
 a single firm can produce the entire market Q at lower cost than could several firms.
Term
 demand curve for a monopolist
Definition
 the market demand curve, that is, slopes down
Term
 P vs. AR for a monopolist
Definition
 P = AR
Term
 MR vs. P for a monopolist
Definition
 MR < P, whereas MR = P for a competitive firm
Term
 D curve vs. MR curve for a monopolist
Definition
 both slope down, but the MR curve is steeper
Term
 the 2 effects Q has on a monopolist's revenue
Definition
 -output effect-input effect
Term
 output effect
Definition
 higher output raises revenue
Term
 input effect
Definition
 lower price reduces revenue
Term
 To sell a larger Q, the monopolist must reduce...
Definition
 the price on all the units it sells
Term
 For a monopolist, MR can be negative if...
Definition
 the price effect exceeds the output effect (e.g., when Common Grounds increases Q from 5 to 6).
Term
 Is a monopoly firm a price taker?
Definition
 No. It's a price maker.
Term
 in a monopoly firm, Q and P are...
Definition
 jointly determined by MC, MR, and the demand curve
Term
 why monopoly has no supply curve
Definition
 because a monopoly firm is...-is a “price-maker,” not a “price-taker” -Q does not depend on P; Q and P are jointly determined by MC, MR, and the demand curve.
Term
 the monopoly e'librium
Definition
 P > MR = MC
Term
 why monopoly results in a deadweight loss
Definition
 -The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC).-The monopoly Q is too low – could increase total surplus with a larger Q.
Term
 why monopoly results in a deadweight loss (simplified)
Definition
 because monopoly e'librium quantity is less than competitive e'librium quantity
Term
 Price discrimination
Definition
 selling the same good at different prices to different buyers.
Term
 the characteristic used in price discrimination
Definition
 willingness to pay (WTP)
Term
 perfect price discrimination
Definition
 when the monopolist produces the competitive quantity, but charges each buyer his or her WTPno dead weight loss
Term
 why perfect price discrimination is impossible
Definition
 -No firm knows every buyer’s WTP-Buyers do not reveal it to sellersbecause of this, firms group customers based on something likely related to WTP, such as age
Term
 some examples of Public Policy Toward Monopolies
Definition
 -Increasing competition with antitrust laws-Regulation-Public ownership-Doing nothing
Term
 public policy towards monopolies by Increasing competition with antitrust laws
Definition
 Ban some anticompetitive practices, allow govt to break up monopolies.
Term
 public policy towards monopolies by regulation
Definition
 -Govt agencies set the monopolist’s price.-For natural monopolies, MC < ATC at all Q, so marginal cost pricing would result in losses.-If so, regulators might subsidize the monopolist or set P = ATC for zero economic profit.
Term
 example of public policy towards monopolies by public ownership
Definition
 USPS
Term
 disadvantage of public policy towards monopolies by public ownership
Definition
 usually less efficient since no profit motive to minimize costs
Term
 why public policy towards monopolies might do nothing
Definition
 The foregoing policies all have drawbacks, so the best policy may be no policy
Term
 many firms have market power, due to
Definition
 -selling a unique variety of a product-having a large market share and few significant competitors
Term
 some ways monopolies arise due to barriers to entry
Definition
 government-granted monopolies, the control of a key resource, or economies of scale over the entire range of output
Term
 this causes a monopoly's marginal revenue to fall below price
Definition
 must reduce price to sell a larger quantity due to downward-sloping demand curve for its product
Term
 Monopoly firms maximize profits by...
Definition
 producing the quantity where marginal revenue equals marginal cost.
Term
Definition
 Since marginal revenue is less than price, the monopoly price will be greater than marginal cost, leading to a deadweight loss.
Term
 Monopoly firms (and others with market power) try to raise their profits by...
Definition
 charging higher prices to consumers with higher willingness to pay. This practice is called price discrimination.
Term
 how policy makers might respond to monopolies
Definition
 by using antitrust laws to promote competition, or by taking over the monopoly and running it
Term
 imperfect competition
Definition
 competition that lies between perfect competition and monopoly
Term
 types of imperfect competition
Definition
 oligopoly and monopolistic competition
Term
 oligopoly
Definition
 only a few sellers offer similar or identical products
Term
 monopolistic competition
Definition
 many firms sell similar but not identical products
Term
 characteristics of monopolistic competition
Definition
 -Many sellers-Product differentiation-Free entry and exit-no long run econ profits-firm has market power-firm has downward sloping D curve-many close substitutes
Term
 MR vs. P in monopolistic competition
Definition
 At each Q, MR < P
Term
 This is what a firm does in monopolistic competition to maximize profot
Definition
 produces Q where MR = MC
Term
 what to plot on a graph when identifying a firm's profit and losses in a competitive market
Definition
 MChorizontal MRATC
Term
 what to plot on a graph when trying to find the profit maximizing Q for a firm in a monopoly
Definition
 MCdownward sloping MRDprofit maximizing Q is where MR = MC
Term
 what to plot on a graph when trying to find a monopoly's profit
Definition
 MCdownward sloping MRDATC
Term
 what to plot on a graph when trying to find a monopolistically competitive firm's short run profits or losses
Definition
 MCATCDdownward sloping MRfirm uses the D curve to set P
Term
 short run firm behavior of monopolistic competition compared to that of a monopoly
Definition
 very similar to monopoly
Term
 long run behavior of monopolistic competition
Definition
 In monopolistic competition, entry and exit drive economic profit to zero. -If profits in the short run: New firms enter market, taking some demand away from existing firms, prices and profits fall.-If losses in the short run: Some firms exit the market, remaining firms enjoy higher demand and prices.
Term
 In monopolistic competition, entry and exit occur until...
Definition
 P = ATC and profit = zero
Term
 Why Monopolistic Competition Is Less Efficient than Perfect Competition
Definition
 1. excess capacity2. markup over marginal cost
Term
 excess capacity in monopolistic competition
Definition
 The monopolistic competitor operates on the downward-sloping part of its ATC curve, produces less than the cost-minimizing output.
Term
 excess capacity in perfect competition competition
Definition
 Under perfect competition, firms produce the quantity that minimizes ATC
Term
 markup over marginal cost under monopolistic competition
Definition
 Under monopolistic competition, P > MC
Term
 markup over marginal cost under perfect competition
Definition
 Under perfect competition, P = MC
Term
 regarding monopolistic competition:Because P > MC,...
Definition
 market quantity < socially efficient quantity
Term
 regarding monopolistic competition:Because ______, market quantity < socially efficient quantity
Definition
 P > MC
Term
 why policy makers can't require firms to reduce prices
Definition
 because they make zero profits
Term
 external effects from the entry of new firms in monopolistic competition
Definition
Term
 The product-variety externality
Definition
 surplus consumers get from the introduction of new products
Term
Definition
 losses incurred by existing firms when new firms enter market
Term
 In monopolistically competitive industries, this naturally leads to the use of advertizing.
Definition
 product differentiation and markup pricing
Term
Definition
 In general, the more differentiated the products, the more advertising firms buy.
Term
Definition
 -Society is wasting the resources it devotes to advertising.-Firms advertise to manipulate people’s tastes.-Advertising impedes competition—it creates the perception that products are more differentiated than they really are, allowing higher markups.
Term
Definition
 -It provides useful information to buyers.-Informed buyers can more easily find and exploit price differences.-Thus, advertising promotes competition and reduces market power.
Term
 why a firm might spend huge amounts of money on advertising
Definition
 to show people the quality of their products
Term
 critics of brand names believe...
Definition
 -Brand names cause consumers to perceive differences that do not really exist.-Consumers’ willingness to pay more for brand names is irrational, fostered by advertising.-Eliminating govt protection of trademarks would reduce influence of brand names, result in lower prices.
Term
 defenders of brand names believe...
Definition
 -Brand names provide information about quality to consumers.-Companies with brand names have incentive to maintain quality, to protect the reputation of their brand names.
Term
 excess capacity
Definition
 when a firm produces less than the quantity that minimizes ATCeach firm in a monopolistically competitive market does this
Term
 the price each firm charges
Definition
 a price above marginal cost
Term
 Monopolistic competition has a deadweight loss caused by...
Definition
 the markup of price over marginal cost
Term
 concentration ratio
Definition
 the percentage of the market’s total output supplied by its four largest firms.
Term
 c'tration ratio vs. competition
Definition
 The higher the concentration ratio, the less competition.
Term
 oligopoly
Definition
 a market structure in which only a few sellers offer similar or identical products.
Term
 Strategic behavior in oligopoly
Definition
 A firm’s decisions about P or Q can affect other firms and cause them to react. The firm will consider these reactions when making decisions.
Term
 game theory
Definition
 the study of how people behave in strategic situations.
Term
 duopoly
Definition
 oligopoly w/ 2 firms
Term
 One possible duopoly outcome
Definition
 collusion
Term
 collusion
Definition
 an agreement among firms in a market about quantities to produce or prices to charge
Term
 cartel
Definition
 a group of firms acting in unison, e.g., AT&T and Verizon in the outcome with collusion
Term
 It is difficult for oligopoly firms to form ______ and honor ______.
Definition
 cartelstheir agreements
Term
 Nash e"librium
Definition
 a situation in which economic participants interacting with one another each choose their best strategy given the strategies that all the others have chosen
Term
 When firms in an oligopoly individually choose production to maximize profit,
Definition
 -oligopoly Q is greater than monopoly Q but smaller than competitive Q.-oligopoly P is greater than competitive P but less than monopoly P.
Term
 the noncooperative oligopoly outcome
Definition
 between the monopoly and competitive outcomes
Term
 Increasing output has these effects on a firm's profits.
Definition
 -output effect-price effect
Term
 output effect
Definition
 If P > MC, increasing output raises profits.
Term
 price effect
Definition
 Raising output increases market quantity, which reduces price and reduces profit on all units sold.
Term
 If output effect > price effect,...
Definition
 the firm increases production.
Term
 If price effect > output effect,...
Definition
 the firm reduces production.
Term
 as the # of firms in an oligopoly increases,...
Definition
 -the price effect becomes smaller-the oligopoly looks more and more like a competitive market-P approaches MC-the market quantity approaches the socially efficient quantity
Term
Definition
 Trade increases the number of firms competing, increases Q, brings P closer to marginal cost
Term
 game theory helps us understand...
Definition
 oligopoly and other situations where “players” interact and behave strategically.
Term
 dominant strategy
Definition
 a strategy that is best for a player in a game regardless of the strategies chosen by the other players
Term
 prisoner' dilemma
Definition
 a “game” between two captured criminals that illustrates why cooperation is difficult even when it is mutually beneficial
Term
 example of a payoff matrix
Definition
 [image]this shows their profits with each decision
Term
 pros and cons of the noncooperative oligopoly e'librium
Definition
 -Bad for oligopoly firms: prevents them from achieving monopoly profits-Good for society:+Q is closer to the socially efficient output+P is closer to MC
Term
 2 strategies that may lead to cooperation
Definition
 -If your rival reneges in one round, you renege in all subsequent rounds.-“Tit-for-tat” Whatever your rival does in one round (whether renege or cooperate), you do in the following round.
Term
 “Tit-for-tat”
Definition
 Whatever your rival does in one round (whether renege or cooperate), you do in the following round.
Term
 production and prices in oligopolies
Definition
 In oligopolies, production is too low and prices are too high, relative to the social optimum.
Term
 role for policy makers in oligopolies
Definition
 -Promote competition-prevent cooperation to move the oligopoly outcome closer to the efficient outcome
Term
 Sherman Antitrust Act
Definition
 1890Forbids collusion between competitors
Term
 Clayton Antitrust Act
Definition
 1914Strengthened rights of individuals damaged by anticompetitive arrangements between firms
Term
 3 business practices that might be stifled by policy makers
Definition
 1. Resale Price Maintenance (“Fair Trade”)2. Predatory Pricing3. Tying
Term
Definition
 Occurs when a manufacturer imposes lower limits on the prices retailers can charge.
Term
 why Resale Price Maintenance (“Fair Trade”) is often opposed
Definition
 because it appears to reduce competition at the retail level
Term
 the market power of the manufacturer is at this level
Definition
 wholesale, not retail
Term
 the legitimate objective of Resale Price Maintenance (“Fair Trade”)
Definition
 preventing discount retailers from free-riding on the services provided by full-service retailers
Term
 predatory pricing
Definition
 preventing discount retailers from free-riding on the services provided by full-service retailersIllegal under antitrust laws, but hard for the courts to determine when a price cut is predatory and when it is competitive & beneficial to consumers.
Term
 Many economists doubt that predatory pricing is a rational strategy because...
Definition
 -It involves selling at a loss, which is extremely costly for the firm.-It can backfire.
Term
 tying
Definition
 Occurs when a manufacturer bundles two products together and sells them for one price (e.g., Microsoft including a browser with its operating system).
Term
 the argument critics use against tying
Definition
 Critics argue that tying gives firms more market power by connecting weak products to strong ones.
Term
 why firms may use tying
Definition
 Firms may use tying for price discrimination, which is not illegal, and which sometimes increases economic efficiency.
Term
 Oligopolists can maximize profits if they...
Definition
 form a cartel and act like a monopolist.
Term
 one reason firms in an oligopoly have a hard time cooperating
Definition
 self-interest
Term
 Policymakers use the antitrust laws to...
Definition
 prevent oligopolies from engaging in anticompetitive behavior such as price-fixing.
Term
 Equation for Nash equilibrium
Definition
 QKE=(n/(n+1))•QPC
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