EC 201 Midterm 2

What is the production function?

A numerical or mathematical expression of a relationship between inputs and outputs. It shows units of total product as a function of units of inputs.

What does it mean to be a price taker?

A person or company that has no control to dictate prices for a good or service. In the trading world, this person is a trader who does not affect the price of the stock if he or she buys or sells shares.

What is vertical differentiation?

A product difference that, from everyone's perspective, makes a product better than rival products ex. A new BMW with a GPS is better than one without

What is an imperfectly competitive industry?

An industry in which individual firms have some control over the price of their output

What is perfect competition?

An industry structure in which there are many firms, each small relative to the industry, producing identical products and in which no firm is large enough to have any control over prices. -in these industries, new competitors can freely enter the market and old firms can exit.

What is a natural monopoly?

An industry that realizes such large economies of scale that single-firm production of that good or service is most cost-efficient

What is a pure monopoly?

An industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

What is game theory?

Analyzes the choices made by rival firms, people, and even governments when they are trying to maximize their own well-being while anticipating and reacting to the actions of others in their environment.

How do wages ensure that all firms hire the efficient number of workers?

As long as all firms have access to the same factor markets and the same factor prices, the last unit of a factor hired with produces the same value in each firm. Each firm will be making its own independent decision, choosing input levels so that marginal revenue products (MRP) equals the input price, but the fact that each faces the same prices for those inputs tells us that in equilibrium, their marginal revenue products would be equal. Certainly, firms will use different technologies and factor combinations, but at the margin, no single profit maximizing firm can get more value out of a factor than that factor's current market price.

How do prices ensure that outputs are efficiently distributed among households?

As long as we are free to choose among all the things that your budget constraint can buy, we will not end up with the wrong things; it is not possible to find a trade that will make us both better off. Again, the price mechanism plays a important role. Each of us faces the same price for the goods that we choose, and that in turn leads us to makes choices that ensure that goods are allocated efficiently among consumers.

How do we determine the MC curve for a monopolist?

At each level of MC, we add together the output quantities from each separate plant.

What are three decisions that firms must make?

-How much output to supply (quantity of product) -How to produce that output (which production technique and technology to use) -How much of each input to demand

What two things cause the industry supply curve to shift?

-In the short run, the industry supply curve shifts if something-a decrease in the price of some input, for instance-shifts the marginal cost curves of all the individual firms simultaneously -In the long run, an increase or decrease in the number of firms- and therefore in the number of individual supply curves-shifts the total industry supply curve. If new firms enter the industry, the industry supply curve moves to the right; if firms exit the industry, the industry supply curve moves to the left

Slope of isoquant

-MPL/MPK

What factors go into explaining why some products have lots of varieties and other products have very few?

-consumers may have different tastes -product variety is narrower when there are gains to coordination (coordination needs can dramatically narrow product choice) -scale economies that make producing different varieties more expensive than a single type can reduce variety

What two conditions hold in the short-run?

-existing firms face limits imposed by some fixed factor of production -new firms cannot enter and existing firms cannot exit an industry

What are the four important sources of market failure?

-imperfect competition -the existence of public goods -the presence of external costs and benefits -imperfect information

What is necessary for a cartel to work?

1) demand for the product must be elastic -If many substitutes are readily available, the price increases may become self-defeating as buyers switch to substitutes 2) the members must play by the rules -if they are holding up prices by restricting output, there is a big incentive for members to cheat by increasing output -breaking ranks can mean temporary huge profits 3)entry into the industry by non-members must also be difficult

steps in the production process

1.Warehouse -Request Production 2.Production -Authorize Production 3.Warehouse -Issue raw materials 4.Production -Create product 5.Warehouse -Receive finished goods

What is monopolistic competition?

A common form of industry (market) structure characterized by a large number of firms, no barriers to entry, and product differentiation.

What is Pareto efficiency?

A condition in which no change is possible that will make some members of society better off without making some other members of society worse off.

What are externalities?

A cost or benefit imposed or bestowed on an individual or a group that is outside, or external to, the transaction

What is the prisoner's dilemma?

A game in which the players are prevented from cooperating and in which each has a dominant strategy that leaves them both worse off than if they could cooperate.

What is an isocost line?

A graph that shows all the combinations of capital and labor available for a given total cost

What is an isoquant?

A graph that shows all the combinations of capital and labor that can be used to produce a given amount of output

What is the long-run equilibrium in a market for monopolistically competitive firms?

A market will produce the amount of goods where the long run marginal cost (LRMC) curve intersects marginal revenue (MR). The price will be set where the quantity produced falls on the average revenue (AR) curve.

normal rate of return

A rate of return on capital that is just sufficient to keep owners and investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds.

What is product differentiation?

A strategy that firms use to achieve market power. Accomplished by producing goods that differ from others in the market.

What is the average variable cost curve?

AVC = TVC / q Average variable cost follows marginal cost but lags behind. As we increase output, marginal cost falls. This decrease in marginal cost pulls down average variable costs. And above the point of diminishing returns, the marginal cost curve rises. However, the average variable cost curve continues to fall because marginal cost is still below average variable cost until this point is reached

What is rent-seeking behavior?

Actions taken by households or firms to preserve positive profits

Can we conclude that monopolistic competition results in an efficient outcome? Why or why not?

Because entry is easy and economic profits are eliminated in the long run, we might conclude that the result of the monopolistic competition is efficient. There are two problems however: -once a firm achieves any degree of market power by differentiating its product, its profit-maximizing strategy is to hold down production and change a price above marginal cost -The final equilibrium in a monopolistically competitive firm is necessarily to the left of the low point on its ATC curve. That means a typical firm in a monopolistically competitive industry will not realize all the economies of scale available.

How do monopolistically competitive firms set their prices in the short-run?

Because revenue does not equal price, small price increase over rivals do not eliminate all customers. The firm see its price respond to its output decisions. The firm chooses the output/price combination that maximizes profit. (So MR = MC)

How do firms decide between two types of technology?

By choosing the technology that minimizes its cost (Cost = (L x Pl) + (K x Pk)

How do we determine the cost of resources that are not explicitly priced?

By considering these factors at their opportunity cost and consider the full cost of production

What is price discrimination?

Changing different prices to different buyers for identical products, where these price differences are not in a inflection of cost differences

Why can't a monopolist charge whatever price it wants?

Constrained by the face that many potential consumers it seeks already have an old version. If the new price is too high, consumers will stay with the old version. Some monopolists may face quite elastic demand curves as a result of the characteristics of the product they sell. -They are seeking max profit and if marginal revenue exceeds marginal cost-> bad

How do we know if monopolistically competitive firms earn profits or losses in the short-run?

If the average total cost is above the market price, than the firm will incur losses, equal to the average total cost minus the market price multiplied by the quantity produced.

What is the average product of labor?

The average mount produced by each unit of a variable factor of production

If a market is contestable, will the firms in an industry with only a few firms behave like a perfectly competitive firms? Why?

Even large oligopolistic firms may end up behaving like perfectly competitive firms. Prices can be pushed to long-run average cost by competition, and positive profits may not persist.

What are barriers to entry?

Factors that prevent new firms from entering and competing in imperfectly competitive industries

Example of a monopolistically competitive industry

Fast food. The market is quite competitive, and yet each firm has a monopoly in its own product.

How do you solve for a Nash Equilibrium?

Find where the dominant strategies intersect

Difference between short-run and long-run

Firm's flexibility in choosing inputs.

How does bargaining power impact the supplier and buyers' boxes in the five forced diagram?

Firms that sell in the product market also buy in the input market. Conditions faced by firms in their input markets are described in the left-hand box, suppliers.

What are public goods?

Goods and services that bestow collective benefits on members of society. Generally, no one can be excluded from enjoying their benefits. classic ex. national defense

What is the difference between vertical and horizontal differentiation?

Horizontal- makes something better or worse vertical- only better

How is monopoly different than a perfectly competitive industry?

In a perfectly competitive market, price equals marginal cost and firms earn an economic profit of zero. In a monopoly, the price is set above marginal cost and the firm earns a positive economic profit.

What is a maximin strategy?

In game theory, a strategy chosen to maximize the minimum gain that can be earned.

What is a dominant strategy?

In game theory, a strategy that is best no matter what the opposition does.

What is Nash Equilibrium?

In game theory, the result of all players playing their best strategy given what their competitors are doing.

Does price equal marginal cost when there is imperfect competition?

In imperfectly competitive markets, with fewer firms competing and limited entry by new firms, prices will not typically equal marginal costs. As a consequence, in a market with firms that have some market power, where firms do not behave as price-takers, we are not guaranteed an efficient mix of output.

What is the role of government in Oligopoly?

It plays a role in protecting smaller firms and ensuring that large firms extend opportunity to these small firms. Another role it can play is to foster an environment in which an oligopoly loses its power for collusion through the entry of others into the market, providing more competition.

What is most common in the Unites States: perfect competition, monopoly, or monopolistic competition?

Monopolistic competition

What is tacit collusion?

Occurs when price- and quantity-fixing agreements among producers are implicit.

What is horizontal differentiation?

Products differ in ways that make them better for some people and worse for others ex. adding sea salt and vinegar to potato chips

What is economic profit?

Profit that accounts for both explicit costs and opportunity costs

What is the equation for profit?

Profit= total revenue - total cost

What are examples of barriers to entry?

Scare resources, economies of scale, government intervention, and aggressive tactics

How do we adjust from the long-run to short-run?

Short-run profits: move in and out of equilibrium -suppose demand increases when the industry is in long-run equilibrium. what will happen? -In equilibrium, each firm has: SRMC=SRAC=LRAC -Firms make no excess profits so that: P=SRMC=SRAC=LRAC and there are enough firms so that supply equals demand

What is the formula for total costs?

TC = TFC + TVC

Long-run

That period of time for which there are no fixed factors of production: Firms can increase or decrease the scale of operation, and new firms can enter and existing firms can exit the industry.

What is imperfect information?

The absence of full knowledge concerning product characteristics, available prices, and so on.

How does the condition P=MC ensure that there is an efficient mix of output?

The condition that ensures that the right things are produced is P = MC. That is, in both the long run and the short run, a perfectly competitive firm will produce at the point where the price of its output is equal to the marginal costs of production. As long as price is above marginal cost, it pays for a firm to increase output. When a firm weighs price and marginal cost, and it weighs the value of its product to society at the margin against the value of the things that could otherwise be produced with the same resources.

How are the demand curves for the perfectly competitive and monopolistically competitive firms different? Why?

The curve that a monopolistic competitor faces is likely to be less elastic than the demand curve that a perfectly competitive firm faces. Demand is more elastic that the demand curve that a monopolist faces because close substitutes for the products of a monopolistic competitor are available.

How might the firm's choices differ in a repeated game as opposed to a one shot game?

The firm will raise its price, but has to consider what the other firms are doing. It must know that its profit will drop unless the other firm raises their price too. The fare increase could just be a signal that both firms would be better off at the higher price and that if one leads and can count on the other to follow, they will both be better off.

What is the shutdown point?

The lowest point on the average variable cost curve. When price falls below the minimum point on AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs

How is the marginal cost curve related to the supply curve?

The marginal cost curve shows how total variable costs changes with single-unit increases in total output -The firm's supply curve in the short-run is its marginal cost curve for prices above the average variable cost

Why does monopoly power create a deadweight loss?

The monopolist's ability to raise its price above marginal cost means that some transactions that would have been advantageous from an overall perspective are not made. This is loss associated with the fact that the higher prices discourage consumption by people whose value of a good exceeds its social cost of production.

Short-run

The period of time for which two conditions hold: The firm is operating under a fixed scale (fixed factor) of production, and firms can neither enter nor exit an industry.

What is antitrust policy?

The policy that the government activity against the monopoly behavior and ensure more competition in the market which is desirable for the society. Implementers are the Federal Trade Commission and the U.S Bureau of Justice

Why under price leadership output will lie between the monopolist and perfectly competitive firm?

The quantity demanded in the market will be produced by a mix of the smaller firms and the dominant firm. For a monopolist, the only customer it faces comes from consumers, who at some price will forgo the good the monopolist produces. In an oligopoly, with a dominant firm practicing price leadership, the existence of the smaller firms (and their willingness to produce output) is also a constraint. For this reason, the output expected under price leadership lies between that of the monopolist and the competitive firm, with prices also set between the two price levels.

What is the marginal rate of technical substitution?

The rate at which a firm can substitute capital for labor and hold output constant

What is a deadweight loss?

The social cost associated with the distortion in consumption from a monopoly price

How does the monopolist determine its output?

They will select the profit-maximizing level of output where MR = MC, and then charge the price for that quantity of output as determined by the market demand curve. If that price is above average cost, they earn positive profits.

What is average total cost?

Total cost divided by the number of units of output; a per-unit measure of total costs

If a group of profit-maximizing oligopolists collude on price and output, will it result in the same price and quantity as the monopolist? Why?

When the group colludes on price and output, the result is the same as it would be if a monopolist controlled the entire industry. That is, the colluding oligopoly will face market demand and produce only up to the point at which marginal revenue and marginal cost are equal (MR = MC) and price will be set above marginal cost.

How does a firm decide whether or not to stay in business?

Whether a firm suffering losses decides to produce or not to produce in the short run depends on the advantages and disadvantages of continuing production. If a firm shuts down, it earns no revenue and has no variable costs to bear. If it continues to produce, it both earns revenue and incurs variable costs. Because a firm must bear fixed costs whether or not it shuts down, its decision depends solely on whether total revenue from operating is sufficient to cover total variable cost.

How is normal rate of return determined?

[(current value - original value) / (original value)] x100

What is a cartel?

a group of firms that gets together and makes joint price and output decisions to maximize joint profits

What are economies of scale?

a proportionate saving in costs gained by an increased level of production.

What is a duopoly?

a two-firm oligopoly

What is market power?

an imperfectly competitive firm's ability to raise price without losing all of the quantity demanded for its product

What is the equation for economic profit?

economic profit= total revenue - total economic cost

Why are barriers to entry important for monopolies?

it makes the market less contestable and less competitive

examples of price discrimination

movie tickets, airline prices, discount coupons, financial aid, quantity discounts

What is market failure?

occurs when resources are misallocated, or allocated inefficiently. The result is waste or lost surplus

How does rent-seeking behavior impact the monopolist's profits?

results in reduced economic efficiency through misallocation of resources, reduced wealth-creation, lost government revenue, heightened income inequality, and potential national decline

What is the slope of an isoquant equal to at the cost minimizing point?

slope of isoquant = slope of isocost (MPl)/(Pl) = (MPk)/(Pk)

What is capital-intensive technology?

technology that relies heavily on capital instead of human labor

What is labor-intensive technology?

technology that relies heavily on human labor instead of capital

production process

the activities, equipment, and resources needed to manufacture a product

What is marginal revenue?

the additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, it is equal to price.

What is the total variable cost?

the cost of all variable inputs used in producing a particular level of output TVC = TC - TFC

What is the marginal product of labor?

the increase in the amount of output from an additional unit of labor

What is the marginal cost?

the increase in total cost that results from producing one more unit of output -reflect changes in variable costs

What are sources of diseconomies of scale?

the marginal cost of a product increases as the output increases

What is production technology?

the quantitative relationship between inputs and outputs

What is long-run competitive equilibrium?

the situation in which the entry and exit of firms has resulted in the typical firm breaking even -Occurs when P=SRMC=SRAC=LRAC and profits are zero

What is total revenue?

the total amount that a firm takes in from the sale of its product: the price per unit times the quantity of output the firm decides to produce (P x q)