Economics 130

oligopoly

few firms. standardized or differentiated product. price limited by mutual inter-dependence, often collusion. significant obstacles to entry. a lot of product differentiation. example: steel

long run production costs

firm can change all input amounts, including plant size. all costs are variable.

long run in pure competition

firms can expand or contract capacity. firms can enter or exit industry. decisions are based on incentives or profit or loss.

short run production costs

fixed costs (TFC): costs that do not vary with output. variable costs (TVC): costs that do vary with output. total cost (TC): sum of TFC and TVC.

economies of scale

for a time, larger plant sizes lead to lower unit costs. an increase of inputs lead to a proportional increase in outputs. labor specialization. managerial specialization. efficient capital. other factors.

industry

group of firms producing similar products, the more particular you are on how similar the products the smaller the number of firms in the industry.

proportion of income

high proportion of income, elastic. example: car. low proportion of income, inelastic. example: salt.

loss minimizing case

in the short run, firm has two choices: produce or shut down. loss from producing is small than loss if firm shuts down.

normal goods

income elasticity is positive. increase in income will lead to a rise in demand.

industry scructure

industries with economies of scale over a wide range of outputs will lead to a few large scale firms. Small firms cannot realize minimum efficient scale (MES) and are not able to compete.

market

interaction between buyers and sellers. markets may be local, national, international. price is discovered in the interactions of buyers and sellers.

stocks

legal document that gives claim to a portion of the profits of the company. common stocks (equity) or preferred stocks (not a liability)

law of diminishing marginal utility

less satisfied by each additional unit consumed.

natural monopoly

long run costs are minimized when only one firm produces the product.

minimum efficient scale (MES)

lowest level of output at which long run average costs are minimized. can determine the structure of industry.

monopolistic competition

many firms. differentiated product. some control over price within narrow limits. relatively easy entry. considerable emphasis on brand. example: retail

income elasticity of demand

measures responsiveness of buyers to a change in their incomes.

cross elasticity of demand

measures responsiveness of purchase of one good to change in the price of another.

price elasticity of supply

measures sellers' responsiveness to price changes. depends on how easily producers can shift resources between alternative uses.

purely competitive demand

perfectly elastic demand. firm produces as much or as little as they wish at the market price. Demand graphs as horizontal line.

immediate market period

perfectly inelastic supply. length of time that producers are unable to respond to price change with change in quantity supplied.

plant

physical plant that performs some manufacturing or distribution function.

determinants of demand curve

preferences. number of buyers. income. prices of related goods. expectations.

law of demand

price goes up and quantity demanded goes down. price goes down and quantity demanded goes up. price acts as an obstacle to buyers.

law of supply

price goes up and quantity supplied goes up. price goes down and quantity supplied goes down. explanation: price acts as an incentive to producers, costs will rise

price floor

prices are set above market price. chronic surpluses.

MR = MC rule

principle that a firm will maximize profit (minimize loss) by producing the output at which marginal revenue and marginal cost are equal, provided the product price is equal or greater than the average variable cost. firm should expand output as long as MR is greater than MC.

inelastic supply

producers not responsive to price changes.

elastic supply

producers responsive to price changes.

productive efficiency

producing goods in the least costly way. using the best technology. using the right mix of resources.

allocative efficiency

producing the right mix of goods. combination of goods most highly valued by society.

time

product demand is more elastic the longer the time period under consideration. short-run demand is inelastic. long-run demand is elastic. quiz: price of heating oil drastically increases, the quantity demanded falls significantly over the long run because consumers are more sensitive to price change if they have more time to respond to the price change.

pure competition

rare in the real world, but provides a standard to compare against. very large number of firms. standardized product. no control over price. easy entry. no nonprice competition. example: agriculture.

marginal cost (MC)

reflects the additional cost associated with producing one more unit of output. MC is a reflection of marginal product and diminishing returns. when diminishing returns begin, the MC begins to rise.

determinants of supply

resource prices. technology. number of sellers. taxes and subsidies. prices in other goods. producer expectations.

law of diminishing returns

resources are of equal quality. technology is fixed. variable resources are added to fixed resources. at some point, MP will fall.

price elasticity of demand

responsiveness of consumers to a price change. quiz: HP sells printers at low prices that use only HP ink cartridges, this reduces price elasticity of demand for HP ink cartridges.

normal profit

return to the entrepreneur and is the amount of money required for entrepreneur to stay in the market.

average revenue

revenue per unit AR = TR/Q = P

price takers

sellers that have no pricing power

price ceiling

set below equilibrium price. rationing problem. black markets.

short run

somewhat elastic supply. too short to change capacity but long enough to adjust to price change. fixed plant. some variable inputs.

income effect

the change in consumption resulting from a change in real income.

determinant of supply, elasticity

time is the primary determinant of elasticity of supply.

total revenue

total amount the seller receives from sale of a product in a particular time period. TR = P x Q

total product (TP)

total quantity that is produced.

luxuries vs necessities

want is elastic. need is inelastic.

market equilibrium

where the demand curve and supply curve intersect. rationing function of prices. efficient allocation.

marginal revenue

extra revenue from 1 more unit. MR = change in TR / change in Quantity

common stocks

1) does not guarantee any rate of return. 2) no intent to return principal to original investors. 3) part of corporation earnings paid out in cash dividends is retained for corporate use. 4) shareholders assume residual position in the overall financial structure of business. 5) common stockholders occupy riskiest position but can gain highest return. 6) usually one vote per common share

forming corporations

1) entrepreneurs hold a meeting. 2) consult a lawyer. 3) write an article of incorporation that includes: name, address, purpose of corporation, names & addresses of initial board of directors, number of directors, capital. 4) send charter of incorporation to appropriate agencies. 5) charter is granted. 6) write bylaws of corporation. 7) stockholder elects board of directors. 8) board chooses company officers.

determinants of demand, elasticity

1) substitutability 2) proportion of income 3) luxuries vs necessities 4) time

economic profit

= accounting profit (revenue - explicit costs) - implicit costs

accounting profit

= revenue - explicit costs

inelastic demand

E < 1 elasticity is less than 1, indicating low responsiveness to price changes. example: 2% decline in price of coffee leads to 1% decline in quantity demanded.

perfectly inelastic demand

E = 0 where a price change results in no change in quantity demanded. shown as vertical line.

unit elasticity

E = 1 elasticity is equal to 1, indicating proportional responsiveness to price changes. example: 2% decline in price of chocolate causes a 2% increase in quantity demanded.

perfectly elastic demand

E = ∞ shown as a horizontal line. quiz: deep ocean water is perfectly elastic, an increase in demand will increase equilibrium quantity but equilibrium price will be unchanged.

elastic demand

E > 1 elasticity is greater than 1, indicating a high responsiveness to changes in price. example: 2% decline in price of flowers results in 4% decline in quantity demanded.

profit maximization: MR = MC

MR = MC rule. for price taker, price = marginal revenue. 1) should firm produce in the short run? 2) how much to produce? 3) calculate profit or loss

average total cost (ATC)

equals total cost (TC) per unit produced (Q). ATC = TC / Q or sum of average fix cost (AFC) plus average variable cost (AVC). ATC = AFC + AVC

average variable cost (AVC)

equals variable costs (TVC) per unit produced (Q). AVC = TVC / Q

partnership

a business owned by two or more people. Advantages: 1) more capital, possible to make business larger & more profitable, also can borrow more money. 2) greater efficiency, each partner specializes. Disadvantages: 1) unlimited liability, each partner responsible for debts or another partner. 2) profit must be shared. 3) possible disagreements. 4) ceases to exist with death of a partner.

substitution effect

a change in the amount that consumers will buy because they buy substitute goods instead.

price elasticity

a measure of the responsiveness to quantity demanded/supplied when a small change in price occurs.

inferior goods

elasticity is negative. increase in income leads to fall in demand. quiz: assume a 3% increase in income produces a 1% decline in sales of Spam, the coefficient of income elasticity of demand for Spam is negative and therefore Spam is an inferior good. (Q 1% / P 3% = negative coefficient 0.333)

constant cost industry

entry and exit of firms does not affect resource prices.

rationing function of prices

ability of the competitive forces of demand and supply to establish at price at which selling and buying decisions are consistent.

imperfect competition

all market structures except pure competition. monopolistic competition. oligopoly. pure monopoly.

demand

amount consumers are willing and able to purchase at a given price.

supply

amount producers are willing and able to sell at a given price. individual supply. market supply.

marginal product (MP)

amount the total product changes when labor changes by one unit. reflects change in output when one more unit of labor is hired.

bonds

an IOU, promissory note to a corporation or government with a specific maturity date at a specific rate for a specified length of time at which principal is paid back in full. 1) bondholder is a creditor to the corporation 2) bond indenture, lending agreement, holds the term of the agreement: maturity date, pattern of payment, retirement schedule of the bond, bond collateral. 3) corporate trustee represents bond holders ensuring that the terms of the bond are met by the corporation

short run supply curve

as long as price exceeds minimum AVC, firm continues producing using the MR = MC rule. supply graph is upsloping line.

sole proprietorship

business owned by one person. Advantages: 1) receives all the profit. 2) one decision maker. 3) easy to start and end business. 4) no corporate income tax, only personal income tax. Disadvantages: 1) responsible for all losses. 2) unlimited liability, extends to personal wealth. 3) limited capital, owner's personal funds. 4) ceases to exist with death of owner.

slope of a linear line

change in Y / change in X = slope quiz: slope of a linear line is 10, if Y decreases by 20, than X decreases by 2 (20/10=2)

market structure

characteristics of an industry that defines the likely behavior and performance of its firms.

pricing power

charge different prices to different buyers based on price elasticities business air travelers = inelastic demand leisure air travelers = elastic demand

average fixed cost (AFC)

equals fixed costs (TFC) per unit produced (Q). AFC = TFC / Q

stocks vs bonds

common stock 1) low risk for corporation because there is no legal obligation to pay the stock back. 2) expensive way to finance a corporation: selling costs, dividends are paid out of corporate earnings; which have been taxed; dilute the original stockholders ownership and their claim to residual profit decreases. bonds: 1) cheap way of financing, bond interest is tax deductible. 2) bondholders have no choice in management. 3) original stockholder right to residual earnings are not diluted. 4) very risky for corporation because bond holders have prior rights to corporation's earnings and if corporation cannot make interest payments can be forced into backrupty

profit maximization: TR - TC

competitive producer will wish to produce at the output level where TR exceeds TC by greatest amount. 1) should firm produce in the short run? 2) how much to produce? 3) calculate profit or loss

financing corporations

corporations obtain long-term financing by selling securities, stocks and bonds.

complementary goods

cross elasticity of demand is negative. example: decrease in price of digital cameras means increase in quantity demanded of memory sticks.

substitute goods

cross elasticity of demand is positive. quiz: apples and oranges are substitute goods, a freeze in Florida destroys orange crop. Ceteris Paribus: price of both apples and oranges increase. quiz: cross price elasticity for bread and potatoes is 0.5 = substitutes quiz: price of gasoline rises, price of corn/ethanol rises = cross price elasticity of demand is positive quiz: 10% price increase in beef causes 20% price increase in pork = 2 coefficient of cross elasticity of demand is positive and are substitutes

independent goods

cross elasticity of demand is zero. price of walnuts does not change quantity demanded of plums.

price elasticity along the demand curve

demand is typically elastic in the high-price (low-quantity) range of the demand curve. demand is typically inelastic in the low-price (high-quantity) range of the demand curve. quiz: manufacturer found that TR decreased when price was lowered from $5 to $4 and that TR decreased when price was raised from $5 to $6 = the demand for pizza is elastic above $5 and inelastic below $5

total revenue test

easiest way to infer whether demand is elastic or inelastic. if total revenue changes in the opposite direction from price, demand is elastic. if total revenue changes in the same direction as price, demand is inelastic. if total revenue does not change when price changes, demand is unit-elastic.

profit maximization in the long run

easy entry and exit. only long run adjustments are considered in analysis. industry's firms have identical costs.

long run

more elastic supply. long enough to adjust capacity to price change. firms can adjust plant size or enter/leave industry. all inputs are variable.

substitutability

more substitutes means elastic. example: candy. less substitutes means inelastic. example: tooth repair.

corporation

most important type of business in the US. key element in developing the US. legal separate entity. Advantages: 1) greater capital: debt (bonds) and equity (common stock) 2) limited liability, stockholder limited to money invested. 3) unlimited life, exist as long as profitable. 4) able to hire specialized management. Disadvantages: 1) pays federal and state tax. 2) double taxation - shareholder dividend also personal income tax. 3) some states have corporate profit and property taxes. 4) increased governmental control.

shut down case

no level of output where the firm can produce and incur smaller loss than its total fixed cost.

preferred stocks

not a liability because there is no maturity time. have no voting rights. can sell or transfer freely. occasionally firms do retire preferred stocks. owners paid before common stocks. have prior claim on the corporation, should it fold.

diseconomies of scale

occur when a firm becomes too large, illustrated by rising part of long run average total cost (ATC) curve. control and coordination problems. communication problems. worker alienation and shirking.

constant returns to scale

occur when average total cost (ATC) is constant over a variety of plant sizes, so an increase in inputs result in a proportionate increase in output.

monopoly

one firm. unique, no close substitutes. considerable price control. blocked entry. emphasis on PR. example: local utilities.

implicit costs

opportunity cost of using self-owned resources. costs that represent forgone opportunities.

firm

organization that owns and operates one or more plants

break even point

output at which firm makes normal profit (TR = TC)

average product (AP)

output that is produced per unit of labor.

economic cost

payment that must be made to obtain and retain the services of a resource.

explicit costs

payments to non-owners for resources they supply.

coefficient of elasticity formula

percentage change in quantity demanded divided by the percentage change in price.