ECON 1030 - Exam 2 Fundamentals
Herfindahl-Hirschman Index formula
(share 1%)^2 + (share 2%)^2 + ... (share n%)^2
Zero accounting profit vs zero economic profit
- 0 accounting profit: covering explicit costs, but NOT implicit costs, so actually negative profit - 0 economic profit: covering both implicit and explicit costs - when we talk about profit, we're talking about economic profit
MC, ATC, AVC curves
- MC intersects AVC and ATC at their respective minimum points - AVC is beneath ATC
What wage will a monopsonist pay?
- NOT the wage where MRP = MRC - where MRP = MRC shows where the firm SHOULD hire - instead they use the lowest wage workers will accept, found by dropping the point where MRP and MRC intersect down onto the labor supply curve
A change/shift in resource demand
- a change in the quantity of a resource demanded at EVERY resource price - an increase in resource demand shifts the resource demand curve right - a decrease in resource demand shifts the resource demand curve left
Oligopoly
- a few large producers - either standardized or differentiated products - extensive entry/exit barriers - producers are price makers
Price taker
- a firm that must accept the dominant prices in the market - cannot affect the market price on its own
inclusive union
- a group formed by merging all workers in a specific industry into a single bargaining group, which aims to increase the wages and benefits of its members - can be small and local or large and national
long-run equilibrium
- a market condition in which firms do not face incentives to enter or exit the market and firms earn a normal profit - occurs when the market price is equal to the minimum ATC
regulated normal profit price
- a regulated price that is equal to the average total cost of production - located where ATC average total cost curve intersects with the demand curve
regulated competitive price
- a regulated price that is equal to the marginal cost of production - located where marginal cost curve intersects with the demand curve - allocatively efficient
least-cost rule
- a rule that states that the cost of producing any given level of output is minimized when the marginal product per dollar spent on a resource is equal for all resources used in production - MP of labor/price of labor = MP of capital / price of capital
mutual interdependence
- a situation in which a change in the strategy followed by one producer will likely affect the sales, profits, and behavior of another producer
collusion
- a situation in which decision makers coordinate their actions to achieve a desired outcome - used to achieve an outcome that would not be possible in the absence of coordinated actions - associated with illegal or anticompetitive behaviors
short-run supply curve
- a supply curve that represents the short-run relationship between price and quantity supplied - for a perfectly competitive firm, the portion of the MC curve that is at or above the minimum point of the AVC curve
All else held constant...
- an increase in demand for a good/service results in an increase in the demand for resources needed to produce it - an increase in the productivity of a resource results in an increase in the demand for the resource - the demand for a resource increases when the price of a substitute resource increases - the demand for a resource decreases when the price of its complementary resource increases and vice versa
Monopolistic competition demand curve
- downwards sloping demand curve - relatively more elastic than monopolies - relatively less elastic than perfectly competitive firms - more unique products have a more vertical curve, products with very similar substitutes have a more horizontal curve
Economic profit for monopolistically competitive firms
- if ATC curve intersects demand curve, it will generate profit - if ATC curve is above demand curve, cannot ever generate profit
Job market vs labor market
- in the market for labor, households are suppliers and firms are demanders - in the market for jobs, firms are suppliers and households are demanders
perfect competition markets
- interaction of large numbers of buyers and sellers - the sellers produce a standardized, or homogenous, product - these sellers are price takers - can sell as much output as they choose to produce at the market price - have the ability to easily enter and exit an industry
perfect competition characteristics (simplified)
- large number of firms - all firms produce identical good - each firm supplies a small portion of overall supply - no single firm can influence the price - no entry barriers limit the number of firms entering or exiting
Monopolistic competition
- large number of sellers - produce a differentiated product - they have some control over price - relatively easy entry/exit
Are ATC and AVC curves variable?
- no, the space between the curves in the AFC, which always declines as a firm produces more output, so that space gets smaller
The perfect monopoly extracts all surplus from consumers, yielding higher profits than any other pricing method when it employs which of the following?
- perfect price discrimination - personal pricing - first-degree price discrimination
The practice of charging each and every consumer the price she is willing and able to pay for a good or service describes
- perfect price discrimination - personal pricing - first-degree price discrimination
Productive efficiency
- producing output (Q) at the lowest possible ATC of production - using the fewest resources possible to produce
Allocative efficiency
- producing the goods an services that are most wanted by consumers in such a way that their MB = MC
What is the difference between shutdown and exiting the market?
- shutdown is a short-run decision, exit can only be made in the long-run - if a firm is generating a loss, it is difficult to shut down and takes time - shutting down can be temporary
monopsony
- single buyer of a good/service/resource - wage/price maker in labor market - can affect price - often a large firm that is the only employer in a market - ex: a mining company in a remote mining town
Characteristics of a monopoly
- single seller - no close substitutes for good/service - market has relatively blocked entry - price maker
marginal cost (MC)
- the additional cost associated with the PRODUCTION of an additional unit change in total cost (TC) / change in output (Q) OR change in total variable cost (TVC) / change in output (Q)
normal profit (zero economic profit)
- the level of profit that occurs when total revenue is equal to total cost - indicates a firm is doing JUST AS WELL as it would have if it had chosen a different product/industry
shutdown point
- the price below which a firm will choose not to operate in the short run - numerically: occurs when marginal revenue equals marginal cost at the minimum AVC - graphically: occurs where the price, or MR curve, intersects the marginal cost curve at the minimum point of the AVC curve
How to determine profit-maximizing price and output
1. For profit maximizing price, find where the MR curve intersects with the MC curve 2. For profit maximizing output, project that quantity up to the demand curve and note the corresponding price
How to calculate if someone is in economic profit or loss at their profit-maximizing output and price
1. Project the profit maximizing quantity up to the average total cost (ATC) curve 2. if ATC > profit maximizing price, they are generating a loss
How to calculate what the allocatively efficient level of output is for a firm based off of a graph
1. allocative efficiency occurs where the MB is equal to the MC 2. Because demand represents MB for consumers, a firm is allocatively efficient where the Demand and MC curves intersect
four characteristics of a perfectly competitive market
1. large number of buyers and sellers 2. standardized product 3. producers are price takers 4. entry and exit are easy
Industries with a four-firm concentration ratio above _____ are considered oligopolies
40% (but 100% is a pure monopoly)
four-firm concentration ratio formula
= (sales of four largest firms/total sales of industry) * 100
What are examples of markets that are and are not perfectly competitive?
ARE: cotton, cucumbers, chlorine ARE NOT: running shoes, cellphones
How to calculate average total cost ATC
ATC = TC/Q ATC = AFC + AVC
Which line is lower, ATC or AVC?
AVC, it takes more effort to minimize that ATC than the AVC
In order for a monopolistically competitive firm to produce at a point that is both productively and allocatively efficient, which of the following has to be true about the profit-maximizing quantity?
Demand = Marginal Cost = ATC just allocative is D = MC just productive is MC = ATC
Which of the following will a firm do when it wants to produce additional output?
It will make decisions at the margin. It will hire additional workers.
Monopolistic competition vs monopoly
MONOPOLY - ONE firm - entry/exit blocked - jumbo jets, first class mail MONOPOLISTIC COMPETITION - several firms, slightly different products - entry/exit easy - software, wine, frozen foods
in a perfectly competitive market, where market price is constant regardless of the number of units sold...
MRP = MP * P marginal revenue product = marginal product * price
explicit costs
Monetary payments made by individuals, firms, and governments for the use of land, labor, capital, and entrepreneurial ability owned by others. Also known as accounting costs.
What is true about firms in monopolistic competition in the short-run?
Monopolistically competitive firms can generate an economic profit, a normal profit, or an economic loss
Profit (in terms of total revenue TR and total cost TC)
Profit = total revenue - total cost pi = TR - TC pi/Q = P - ATC
average product (AP)
TP / units of resource
dominant strategy
a situation in which a particular strategy yields the highest payoff for a decision maker regardless of the other decision makers strategy
long-run supply curve
a supply curve that represents the long-run relationship between price and quantity supplied
Indicate the two most common numerical indicators of market concentration
The four-firm concentration ratio (CR4) The Herfindahl-Hirschman Index (HHI)
increasing marginal returns
a characteristic of production whereby the marginal product of the next unit of a variable resource utilized is greater than that of the previous variable resource
diminishing marginal returns
a characteristic of production whereby the marginal product of the next unit of a variable resource utilized is less than that of the previous variable resource
four-firm concentration ratio (CR4)
a concentration ratio that measures the percentage of sales by the four largest firms in a particular industry
economies of scale
a condition in which the long-run ATC of production DECREASES as production increases - it pays to get bigger
constant returns to scale
a condition in which the long-run ATC of production remains CONSTANT as production increases - optimal size depends on marginal revenue (MR)
diseconomies of scale
a condition in which the long-run average total cost of production INCREASES as production increases - it pays to scale back/get smaller
short-run average total cost curve (ATC)
a curve showing the average total cost for different levels of output when at least one input of production is fixed, typically plant capacity
long-run average total cost curve (LRATC)
a curve showing the lowest average total cost possible for any given level of output (Q) when all inputs of production are variable
The marginal revenue product associated with hiring one additional worker is: Multiple choice question.
a downward-sloping line similar to the marginal product
demand curve
a graphical representation of the relationship between the price of a good, service, or resource and the quantities consumers are willing and able to buy over a fixed period of time
cartel
a group of competing companies that aim to maximize joint profits by coordinating their policies to fix prices, manipulate output, or restrict comeptition
game tree
a mapping tool that shows the strategies available to players engaged in a sequential game as well as the potential outcomes received by those players
Herfindahl-Hirschman Index (HHI)
a market concentration index calculated by summing the squared percentage of sales from all firms in a particular industry
kinked demand model
a model where noncollusive oligopolistic firms ignore other firms price increases but match their price decreases, a process that results in a kink on the demand curve faced by each firm operating in the market
price leadership
a practice used by the dominant firm in a noncollusive oligopolistic market to signal price changes
repeated game
a situation in which a game is played a (potentially infinite) number of times, with the players choosing a strategy each time
payoff matrix
a table showing the potential outcomes arising from the choices made by decision makers
derived demand
a type of demand specific to resources that occurs as a result of the demand for the goods and services produced by those resources ex: if people want sushi (product), there will be a derived demand for sushi chefs (resource)
Derived demand refers to:
a type of demand that is specific to resources.
Federal Trade Commission Act (1914)
an antitrust law that made "unfair methods of competition" and "unfair or deceptive acts or practices" illegal
Clayton Act (1914)
an antitrust law that prohibits mergers that would substantially lessen competition or create a monopoly, as well as some specific business practices such as tying contracts
natural monopoly
an industry in which economies of scale are so extensive that the market is better served by one firm
constant-cost industry
an industry in which the firms' cost structures do not vary with changes in production
Nash equilibrium
an outcome in which decision makers choose their dominant strategy and each has no incentive to independently change their strategy (there can be multiple Nash equilibriums)
barriers to entry
any impediments that prevent firms from entering a market or industry
A firm will purchase a resource if the ____________ associated with the purchase is greater than or equal to its cost.
benefit
marginal revenue (MR)
change in a firms total revenue that results from a one-unit change in output sold MR = change in TR / change in Q
What types of markets are often price taker/ perfect competition markets?
commodity markets (no differentiation, ex: corn)
Governments usually regulate monopolies because they want to achieve a
competitive outcome or lower prices
How to calculate the four-firm concentration ratio for an industry from a table
consider only the 4 firms with the largest sales, add their sales together, then divide by the total OR add the market shares of the top four firms
In economics, we refer to a situation in which there is only one firm but no real barriers to entry as a
contestable market
variable costs
costs that change with the amount of output produced, increasing as production increases and decreasing as production decreases
fixed costs
costs that do not change with the amount of output produced
The difference between the economic surplus when the market is at its competitive equilibrium and the economic surplus when the market is not in equilibrium is the
deadweight loss
When economists refer to resource demand being a derived demand, they mean that the demand for the resource:
depends on the demand for the goods and services produced by the resource
How to calculate each companies percentage of sales (market share) from a table
divide each companies sales by the industry total sales
The demand faced by a pure monopoly is
downwards sloping
__________ profit creates an incentive for other monopolistically competitive firms to enter the market.
economic
When monopolistically competitive firms follow the marginal revenue and the marginal cost rule, the result can be __________ profits, _________ profits, or even losses, depending on market conditions.
economic profits, normal profits
In the presence of _______ profits, firms enter a monopolistically competitive market until the market reaches the point at which the firms are generating a(n) ___________ profit; then entry stops and the market settles into its _______ equilibrium
economic, normal, long
When do firms enter and exit markets?
enter/exit until market price reaches the point where normal profit is generated, then entry/exit stops and long-run equilibrium is reached
economic costs (formula)
explicit costs + implicit costs
What does the demand and MR curve look like for a perfectly competitive market?
flat, MR = d
relationships between MC, ATC, and AVC
if MC > ATC, ATC increases if MC > AVC, AVC increases if MC < ATC, ATC decreases if MC < AVC, AVC decreases if MC = ATC, ATC is unchanged if MC = AVC, AVC unchanged
Profit rules
if P > ATC (price is greater than cost per unit), then profit >0 if P = ATC, profit = 0 if P<ATC, then profit < 0
Government regulation of ________ __________ can take several forms, such as
imposing a normal profit price or a competitive price
A production decision at the margin includes the decision to
increase additional output
The objective of each union is to
increase the wage earned by its members.
Firms use price discrimination to
increase their profits
Compared to perfect competition, a benefit of monopolistic competition for consumers is
increased product variety
Output requires
inputs
The payment name for capital is
interest
All physical and mental activity devoted to producing goods and services is classified as the resource
labor
Resources, sometimes referred to as "gifts of nature," are classified as
land
antitrust laws
laws designed to prevent firms from engaging in behaviors that would lessen competition in a market
Monopolies produce ______ output than competitive markets and are likely to hire _____ labor
less, less
When a pure monopoly practices first-degree price discrimination, the demand curve becomes the
marginal revenue curve
Profit maximization implies that monopoly firms should expand production up to the point where
marginal revenue equals marginal cost
Optimal Resource Utilization Rule
marginal revenue product (MRP) = marginal resource cost (MRC)
If you live in a town or a city that has a single provider of electricity or natural gas, then that natural monopoly provider
may be subject to price regulation
The presence of many monopolistically competitive firms in an industry makes the firm unable to produce enough output to reach the _______________ average total cost, so the firms have ________________ capacity to produce
minimu, excess
Does an increase in wages shift labor demand?
no, it shifts quantity of labor demanded
real wage formula
nominal wage / price of output
The level of profit that occurs when total revenue is equal to total cost is
normal profit
The behavior followed by __________ firms needs to be strategic, given that they face other competitors in their markets
oligopolistic
What is a price taker market?
one with perfect competition
Capital is sometimes divided into
physical capital and human capital
if pi.... then profit
pi>0 then firm generates economic profit pi=0 then firm generates a normal profit pi<0 then firm generates a loss
Monopolistically competitive firms are unable to produce enough output to reach the minimum average total cost because of the
presence of other monopolistically competitive firms in the industry
total revenue
price * quantity
The demand for a perfectly competitive firm's product is a horizontal line originating at the market
price / value
Compared to an unregulated natural monopoly, what is true about the price charged and quantity produced when a natural monopoly is regulated?
price is lower and quantity is higher (this is true for both normal profit price and competitive price regulation)
Price discrimination is only possible when a firm is a
price maker
Production/ Shutdown Rule
produce a loss if AVC <= P < ATC shutdown if P<AVC
Profit Maximizing Rule
produce at the quantity (Q) at which Marginal Revenue (MR) = Marginal Cost (MC)
Profit (in terms of price, average total cost ATC, and output Q)
profit = profit per unit * output profit = (average revenue - ATC)*output pi = (P-ATC)*Q
In the short run, as the price rises
quantity supplied rises
The payment name for land is
rent
Given that oligopolistic firms face other competitors in their markets, their behavior must definitely be
strategic
How to calculate the Herfindahl-Hirschman Index using a table
take the market share for each firm, square it, then add all the results
Monopoly power
the ability of a monopoly to influence prices by controlling the quantities that it produces in the market
nominal wage
the actual number of dollars received in exchange for one''s labor
marginal resource cost (MRC)
the additional cost incurred as a result of utilizing one more unit of a variable resource (ex: labor, capital) MRC = change in total resource cost / change in resource quantity
The marginal resource cost of capital is
the additional cost incurred as a result of utilizing one more unit of capital.
marginal profit (MP)
the additional output produced as a result of utilizing one more unit of a variable resource MP = change in TP / change in variable resource
marginal product (MP)
the additional output produced as a result of utilizing one more unit of a variable resource (ex: labor, capital) MP = change in total product (TP) / change in variable resource
marginal product of capital.
the additional output produced as a result of utilizing one more unit of capital is known as
marginal product of labor (MPL)
the additional output produced with another unit of labor
marginal revenue product (MRP)
the additional revenue generated as a result of utilizing one more unit of a variable resource (ex: labor, capital) MRP = change in total revenue / change in resource quantity
first-mover advantage
the advantage that a player receives by moving first in a sequential game, and thereby influencing the set of possible outcomes
second-degree price discrimination / block pricing
the practice of charging different prices per unit for different quantities, or blocks, or a good or service (ex: 20 oz of laundry detergent for $4, 50 oz for $7)
Marginal revenue (MR)
the change in a firms total revenue that results from a one-unit change in output produced and sold
economic costs
the costs associated with the use of resources; the sum of explicit and implicit costs
In competitive labor markets, the equilibrium wage depends on
the demand for and the supply of labor.
Sherman Act (1890)
the first antitrust law enacted in the US, which made "every contract, combination, or conspiracy in restraint of trade " illegal
In competitive labor markets, the wage depends on
the for and the of labor
economic profit
the level of profit that occurs when total revenue is greater than total cost
loss
the level of profit that occurs when total revenue is less than total cost
minimum efficiency scale
the lowest level of output at which the long-run ATC is minimized
implicit costs
the opportunity costs of using owned resources; costs for which no monetary payment is explicitly made
market share
the percentage of total market sales accruing to one specific firm
first-degree price discrimination / perfect price discrimination / personal pricing
the practice of charging each and every consumer the price that they are willing and able to pay for a good or service
third-degree price discrimination
the practice of dividing market participants into groups based on their elasticities of demand in order to charge each group a different price for the same good or service (ex: coupons are only used by consumers that are sensitive to price changes)
Price discrimination is best described as
the practice of selling the same good or service to different consumers at different prices
price discrimination
the practice of selling the same good or service to different consumers at different prices (ex: airplane seats) (no resale can occur)
limit pricing
the practice used by the dominant firm in a noncollusive oligopolistic market to prevent the entry of new firms by establishing a price lower than the short-run profit-maximizing relationship
backwards induction
the process of identifying optimal strategies by starting at the end of a game tree and moving towards its origin
unregulated monopoly price
the profit-maximizing price that will result from an unregulated monopolistic market
real wage
the quantity of goods and services that can be bought with (the purchasing power of) one's nominal wage
The circular-flow model shows how households and firms interact in two key markets
the resource market and the product market
product differentiation
the strategy of distinguishing one firms product from the competing products of other firms
game theory
the study of the strategic behavior of decision makers
short run
the time period in which at least one input is fixed but others can be changed
long run
the timer period in which all inputs of production can be changed
total product (TP)
the total amount of output produced with a given amount of resources Total Product (TP) = total output (Q)
total product (TP)
the total amount of output produced with a given amount of resources (TP=total output)
excess capacity
the underutilization of resources that occurs when the quantity of output a firm chooses to produce is less than the quantity that minimizes the average total cost (ATC)
purchasing power
the value of a monetary amount expressed in terms of the goods and services it can buy
average total cost (ATC)
total cost (TC) / output (Q) OR AFC + AVC total cost per unit
total cost (TC)
total fixed cost (TF) + total variable cost (TVC)
Average Fixed Cost (AFC)
total fixed cost (TFC) / output (Q) fixed cost per unit
economic profit (as measure)
total revenue - economic costs
accounting profit
total revenue - explicit costs of production
average revenue
total revenue / number of units sold TR / number of units
To affect the quantity demanded by consumers, a monopoly must change the price of its products which also affects
total revenue and marginal revenue
average variable cost (AVC)
total variable cost (TVC) / output (Q) variable cost per unit
Where is profit maximizing quantity for a pure monopoly?
where MR = MC, NOT where TR is highest