Economics Chapters 9-18

Competitive Market

A competitive market, sometimes called a perfectly competitive market, has two characteristics: There are many buyers and many sellers in the market. The goods offered by the various sellers are largely the same. a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker — no one influences the price

The Firm's Long-Run Decision to Exit or Enter a Market

A firm should exit is total revenue is less than total cost Exit if price is less than average total costs

Free Rider

A free rider is a person who receives the benefit of a good but does not pay for it. Because fireworks are not excludable, people have an incentive to be free riders. Because people would have an incentive to be free riders rather than ticket buyers, the market would fail to provide the efficient outcome.

Cartel

A group of firms acting in unison

Monopoly: Profit Maximization

A monopoly maximizes profit by choosing the quantity at which marginal revenue equals marginal cost (point A). It then uses the demand curve to find the price that will induce consumers to buy that quantity (point B).

Should a tariff be part of the new trade policy?

A tariff has an impact only if Isoland becomes a textile importer. In this case, a tariff moves the economy closer to the no-trade equilibrium and, like most taxes, causes deadweight losses. A tariff improves the welfare of domestic producers and raises revenue for the government, but these gains are more than offset by the losses suffered by consumers. The best policy, from the standpoint of economic efficiency, would be to allow trade without a tariff.

Coase theorem

According to the Coase theorem, if private parties can bargain over the allocation of resources at no cost, then the private market will always solve the problem of externalities and allocate resources efficiently. To see how the Coase theorem works, consider an example. Suppose that Dick owns a dog named Spot. Spot barks and disturbs Jane, Dick's neighbor. Dick gets a benefit from owning the dog, but the dog confers a negative externality on Jane. Should Dick be forced to send Spot to the pound, or should Jane have to suffer sleepless nights because of Spot's barking? Consider first what outcome is socially efficient. A social planner, considering the two alternatives, would compare the benefit that Dick gets from the dog to the cost that Jane bears from the barking. If the benefit exceeds the cost, it is efficient for Dick to keep the dog and for Jane to live with the barking. Yet if the cost exceeds the benefit, then Dick should get rid of the dog. According to the Coase theorem, the private market will reach the efficient outcome on its own. How? Jane can simply offer to pay Dick to get rid of the dog. Dick will accept the deal if the amount of money Jane offers is greater than the benefit of keeping the dog. By bargaining over the price, Dick and Jane can always reach the efficient outcome. For instance, suppose that Dick gets a $500 benefit from the dog and Jane bears an $800 cost from the barking. In this case, Jane can offer Dick $600 to get rid of the dog, and Dick will gladly accept. Both parties are better off than they were before, and the efficient outcome is reached.

Externality

An externality arises when a person engages in an activity that influences the well-being of a bystander but neither pays nor receives compensation for that effect. If the impact on the bystander is adverse, it is called a negative externality. If it is beneficial, it is called a positive externality. The exhaust from automobiles is a negative externality because it creates smog that other people have to breathe. Because drivers may ignore this externality when deciding what cars to buy and how much to use them, they tend to pollute too much. The federal government addresses this problem by setting emission standards for cars. It also taxes gasoline to reduce the amount that people drive. Restored historic buildings convey a positive externality because people who walk or ride by them can enjoy the beauty and sense of history that these buildings provide. Building owners do not get the full benefit of restoration and, therefore, tend to tear down older buildings too quickly. Many local governments respond to this problem by regulating the destruction of historic buildings and by providing tax breaks to owners who restore them.

Why the Long-Run Supply Curve Might Slope Upward

Because firms can enter and exit more easily in the long run than in the short run, the long-run supply curve is typically more elastic than the short-run supply curve.

Positive externalities

Beyond these private benefits, however, education also yields positive externalities. One externality is that a more educated population leads to more informed voters, which means better government for everyone. Another externality is that a more educated population tends to result in lower crime rates. A third externality is that a more educated population may encourage the development and dissemination of technological advances, leading to higher productivity and wages for everyone. Because of these three positive externalities, a person may prefer to have neighbors who are well educated. the demand curve does not reflect the value to society of the good. Because the social value is greater than the private value, the social-value curve lies above the demand curve. The optimal quantity is found where the social-value curve and the supply curve intersect. Hence, the socially optimal quantity is greater than the quantity that the private market would naturally reach on its own. Once again, the government can correct the market failure by inducing market participants to internalize the externality. The appropriate response in the case of positive externalities is exactly the opposite to the case of negative externalities. To move the market equilibrium closer to the social optimum, a positive externality requires a subsidy. In fact, that is exactly the policy the government follows: Education is heavily subsidized through public schools and government scholarships.

Rival in Competition

Can one person's use of the good reduce another person's ability to use it?

What Causes the Labor-Supply Curve to Shift?

Changes in Tastes: In 1950, 34 percent of women were employed at paid jobs or looking for work. By 2015, that number had risen to 57 percent. Although there are many explanations for this development, one of them is changing tastes, or attitudes toward work. Sixty-five years ago, it was the norm for women to stay at home and raise their children. Today, the typical family size is smaller, and more mothers choose to work. The result is an increase in the supply of labor. Changes in Alternative Opportunities: The supply of labor in any one labor market depends on the opportunities available in other labor markets. If the wage earned by pear pickers suddenly rises, some apple pickers may choose to switch occupations, causing the supply of labor in the market for apple pickers to fall. Immigration: Movement of workers from region to region, or country to country, is another important source of shifts in labor supply. When immigrants come to the United States, for instance, the supply of labor in the United States increases and the supply of labor in the immigrants' home countries falls. In fact, much of the policy debate about immigration centers on its effect on labor supply and, thereby, equilibrium wages in the labor market.

Club Goods

Club goods are excludable but not rival in consumption. For instance, consider fire protection in a small town. It is easy to exclude someone from using this good: The fire department can just let her house burn down. But fire protection is not rival in consumption: Once a town has paid for the fire department, the additional cost of protecting one more house is small. (We discuss club goods again in Chapter 15, where we see that they are one type of a natural monopoly.) Netflix — can prevent people from having netflix, but more people who have it doesn't prevent someone else from enjoying it.

Common Resources

Common resources are rival in consumption but not excludable. For example, fish in the ocean are rival in consumption: When one person catches fish, there are fewer fish for the next person to catch. But these fish are not an excludable good because it is difficult to stop fishermen from taking fish out of a vast ocean.

Tragedy of the Commons

Common resources, like public goods, are not excludable: They are available free of charge to anyone who wants to use them. Common resources are, however, rival in consumption: One person's use of the common resource reduces other people's ability to use it. Thus, common resources give rise to a new problem: Once the good is provided, policymakers need to be concerned about how much it is used. This problem is best understood from the classic parable called the Tragedy of the Commons. The problem with the field — too many people use it, the sheep will eat up the grass, and no one will have a place for their sheep to graze

U-Shaped Average Total Cost

Conrad's average-total-cost curve is U-shaped, as shown in Figure 4. To understand why, remember that average total cost is the sum of average fixed cost and average variable cost. Average fixed cost always declines as output rises because the fixed cost is getting spread over a larger number of units. Average variable cost usually rises as output increases because of diminishing marginal product. Average total cost reflects the shapes of both average fixed cost and average variable cost. At very low levels of output, such as 1 or 2 cups per hour, average total cost is very high. Even though average variable cost is low, average fixed cost is high because the fixed cost is spread over only a few units. As output increases, the fixed cost is spread over more units. Average fixed cost declines, rapidly at first and then more slowly. As a result, average total cost also declines until the firm's output reaches 5 cups of coffee per hour, when average total cost is $1.30 per cup. When the firm produces more than 6 cups per hour, however, the increase in average variable cost becomes the dominant force, and average total cost starts rising. The tug of war between average fixed cost and average variable cost generates the U-shape in average total cost. Variable costs increase

Negative Externalities

For each unit of aluminum produced, a certain amount of smoke enters the atmosphere. Because this smoke creates a health risk for those who breathe the air, it is a negative externality. Because of the externality, the cost to society of producing aluminum is larger than the cost to the aluminum producers. For each unit of aluminum produced, the social cost includes the private costs of the aluminum producers plus the costs to those bystanders affected adversely by the pollution.

Rising Marginal Cost

Has positive slope Conrad's marginal cost rises as the quantity of output produced increases. This upward slope reflects the property of diminishing marginal product. When Conrad produces a small quantity of coffee, he has few workers, and much of his equipment is not used. Because he can easily put these idle resources to use, the marginal product of an extra worker is large, and the marginal cost of an extra cup of coffee is small. By contrast, when Conrad produces a large quantity of coffee, his shop is crowded with workers, and most of his equipment is fully utilized. Conrad can produce more coffee by adding workers, but these new workers have to work in crowded conditions and may have to wait to use the equipment. Therefore, when the quantity of coffee produced is already high, the marginal product of an extra worker is low, and the marginal cost of an extra cup of coffee is large.

Oligopoly Decisions

If the oligopolists do not form a cartel—perhaps because the antitrust laws prohibit it—they must each decide on their own how much water to produce. To see how the increase in the number of sellers affects the outcome, consider the decision facing each seller. At any time, each well owner has the option to raise production by one gallon. In making this decision, the well owner weighs the following two effects: The output effect: Because price is above marginal cost, selling one more gallon of water at the going price will raise profit. The price effect: Raising production will increase the total amount sold, which will lower the price of water and lower the profit on all the other gallons sold. If the output effect is larger than the price effect, the well owner will increase production. If the price effect is larger than the output effect, the owner will not raise production. (In fact, in this case, it is profitable to reduce production.) Each oligopolist continues to increase production until these two marginal effects exactly balance, taking the other firms' production as given.

Dominant Strategy

In game theory, a strategy that is best for a player in a game regardless of the strategies chosen by the other players. In the case of bonnie and Clyde, confessing is the best strategy, even though they could have walked free in other scenarios.

Oligopoly: Maximizing profits

Like monopolists, oligopolists are aware that increasing the amount they produce reduces the price of their product, which in turn affects profits. Therefore, they stop short of following the competitive firm's rule of producing up to the point where price equals marginal cost. We can now see that a large oligopoly is essentially a group of competitive firms. A competitive firm considers only the output effect when deciding how much to produce: Because a competitive firm is a price taker, the price effect is absent. Thus, as the number of sellers in an oligopoly grows larger, an oligopolistic market looks more and more like a competitive market. The price approaches marginal cost, and the quantity produced approaches the socially efficient level.

If the government allows Isolandians to import and export textiles, what will happen to the price of textiles and the quantity of textiles sold in the domestic textile market?

Once trade is allowed, the Isolandian price of textiles will be driven to equal the price prevailing around the world. If the world price is now higher than the Isolandian price, our price will rise. The higher price will reduce the amount of textiles Isolandians consume and raise the amount of textiles that Isolandians produce. Isoland will, therefore, become a textile exporter. This occurs because, in this case, Isoland has a comparative advantage in producing textiles. Conversely, if the world price is now lower than the Isolandian price, our price will fall. The lower price will raise the amount of textiles that Isolandians consume and lower the amount of textiles that Isolandians produce. Isoland will, therefore, become a textile importer. This occurs because, in this case, other countries have a comparative advantage in producing textiles.

Private Goods

Private goods are both excludable and rival in consumption. Consider an ice-cream cone, for example. An ice-cream cone is excludable because it is possible to prevent someone from eating one—you just don't give it to her. An ice-cream cone is rival in consumption because if one person eats an ice-cream cone, another person cannot eat the same cone. Most goods in the economy are private goods like ice-cream cones: You don't get one unless you pay for it, and once you have it, you are the only person who benefits.

Monopoly's profit

Profit = Total Revenue - Total Cost Profit = (price - total average Revenue) times quantity

Profit is maximized (for competitive markets)

Profit is maximized, for competitive markets, when marginal revenue equals marginal cost If marginal revenue is greater than marginal cost, the firm should increase its output. If marginal cost is greater than marginal revenue, the firm should decrease its output. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal.

Public Goods

Public goods are neither excludable nor rival in consumption. That is, people cannot be prevented from using a public good, and one person's use of a public good does not reduce another person's ability to use it. For example, a tornado siren in a small town is a public good. Once the siren sounds, it is impossible to prevent any single person from hearing it (so it is not excludable). Moreover, when one person gets the benefit of the warning, she does not reduce the benefit to anyone else (so it is not rival in consumption).

Contreversial practices with oligpolies

Resale Price Maintenance: One example of a controversial business practice is resale price maintenance. Imagine that Superduper Electronics sells Blu-ray disc players to retail stores for $50. If Superduper requires the retailers to charge customers $75, it is said to engage in resale price maintenance. Any retailer that charged less than $75 would violate its contract with Superduper. Some may want to sell for less because they may have more demand and make more money, so they may cheat within the collusion. Predatory Pricing: Firms with market power normally use that power to raise prices above the competitive level. But should policymakers ever be concerned that firms with market power might charge prices that are too low? This question is at the heart of a second debate over antitrust policy. Imagine that a large airline, call it Coyote Air, has a monopoly on some route. Then Roadrunner Express enters and takes 20 percent of the market, leaving Coyote with 80 percent. In response to this competition, Coyote starts slashing its fares. Some antitrust analysts argue that Coyote's move could be anticompetitive: The price cuts may be intended to drive Roadrunner out of the market so Coyote can recapture its monopoly and raise prices again. Such behavior is called predatory pricing. (Like With rockefeller) Tying: A third example of a controversial business practice is tying. Suppose that Makemoney Movies produces two new films—The Avengers and Hamlet. If Makemoney offers theaters the two films together at a single price, rather than separately, the studio is said to be tying its two products.

Price Discrimination

So far, we have been assuming that the monopoly firm charges the same price to all customers. Yet in many cases, firms sell the same good to different customers for different prices, even though the costs of producing for the two customers are the same. This practice is called price discrimination. It is used because the firm wants to sell a good to the point that maximizes profits. This point is less than what is socially efficient. Thus, there is still places in the graph in which a monopoly firm can make money. This part is the deadweight loss. A firm can sell to the demand that wants to pay less than the profit maximizing price, but still more than the cost to produce the good by charging these costumers less. Airplane tickets are an example of price discrimination: Seats on airplanes are sold at many different prices. Most airlines charge a lower price for a round-trip ticket between two cities if the traveler stays over a Saturday night. At first, this seems odd. Why should it matter to the airline whether a passenger stays over a Saturday night? The reason is that this rule provides a way to separate business travelers and leisure travelers. A passenger on a business trip has a high willingness to pay and, most likely, does not want to stay over a Saturday night. By contrast, a passenger traveling for personal reasons has a lower willingness to pay and is more likely to be willing to stay over a Saturday night. Thus, the airlines can successfully price discriminate by charging a lower price for passengers who stay over a Saturday night.

price takers

Specifically, any change in Isoland's trade policy will not affect the world price of textiles. The Isolandians are said to be price takers in the world economy. That is, they take the world price of textiles as given. Isoland can be an exporting country by selling textiles at this price or an importing country by buying textiles at this price.

Monopoly: Marginal Revenue<price of the good

Table 1 shows a result that is important for understanding monopoly behavior: A monopolist's marginal revenue is less than the price of its good. For example, if the firm raises production of water from 3 to 4 gallons, it increases total revenue by only $4, even though it sells each gallon for $7. For a monopoly, marginal revenue is lower than price because a monopoly faces a downward-sloping demand curve. To increase the amount sold, a monopoly firm must lower the price it charges to all customers. Hence, to sell the fourth gallon of water, the monopolist must earn $1 less revenue for each of the first 3 gallons. This $3 loss accounts for the difference between the price of the fourth gallon ($7) and the marginal revenue of that fourth gallon ($4).

Corrective Taxes

Taxes enacted to deal with the effects of negative externalities are called corrective taxes An ideal corrective tax would equal the external cost from an activity with negative externalities, and an ideal corrective subsidy would equal the external benefit from an activity with positive externalities. Regulation: The EPA could tell each factory to reduce its pollution to 300 tons of glop per year. Corrective tax: The EPA could levy a tax on each factory of $50,000 for each ton of glop it emits. Most economists prefer the tax. To explain this preference, they would first point out that a tax is just as effective as regulation in reducing the overall level of pollution. The EPA can achieve whatever level of pollution it wants by setting the tax at the appropriate level. The higher the tax, the larger the reduction in pollution. If the tax is high enough, the factories will close down altogether, reducing pollution to zero. In essence, the corrective tax places a price on the right to pollute. Just as markets allocate goods to those buyers who value them most highly, a corrective tax allocates pollution to those factories that face the highest cost of reducing it. Thus, the EPA can achieve any level of pollution at the lowest total cost by using a tax. Economists also argue that corrective taxes are better for the environment. Under the command-and-control policy of regulation, the factories have no reason to reduce emission further once they have reached the target of 300 tons of glop. By contrast, the tax gives the factories an incentive to develop cleaner technologies because a cleaner technology would reduce the amount of tax the factory has to pay.

What causes the labor demand curve to shift?

The Output Price: The value of the marginal product is marginal product times the price of the firm's output. Thus, when the output price changes, the value of the marginal product changes, and the labor-demand curve shifts. An increase in the price of apples, for instance, raises the value of the marginal product of each worker who picks apples and, therefore, increases labor demand from the firms that supply apples (shifts to right). Conversely, a decrease in the price of apples reduces the value of the marginal product and decreases labor demand. Technological Change: Between 1960 and 2015, the output a typical U.S. worker produced in an hour rose by 195 percent. Why? The most important reason is technological progress: Scientists and engineers are constantly figuring out new and better ways of doing things. This has profound implications for the labor market. Advances in technology typically raise the marginal product of labor, which in turn increases the demand for labor and shifts the labor-demand curve to the right. The Supply of Other Factors: The quantity of one factor of production that is available can affect the marginal product of other factors. The productivity of apple pickers depends, for instance, on the availability of ladders. If the supply of ladders declines, the marginal product of apple pickers will decline as well, reducing the demand for apple pickers. We consider the linkage among the factors of production more fully later in the chapter.

Total Cost

The amount that the firm pays to buy inputs the market value of the inputs a firm uses in production

Total Revenue

The amount that the firm receives for the sale of its output

Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses?

The answer depends on whether the price rises or falls when trade is allowed. If the price rises, producers of textiles gain, and consumers of textiles lose. If the price falls, consumers gain, and producers lose. In both cases, the gains are larger than the losses. Thus, free trade raises the total welfare of Isolandians.

Efficient Scale

The bottom of the U-shape occurs at the quantity that minimizes average total cost.

Demand and Marginal-Revenue Curves for a Monopoly

The demand curve shows how the quantity sold affects the price of the good. The marginal-revenue curve shows how the firm's revenue changes when the quantity increases by 1 unit. Because the price on all units sold must fall if the monopoly increases production, marginal revenue is less than the price.

supply and demand for labor

The firm is competitive in the market for the good and in the market for labor Second, we assume that the firm is profit-maximizing. Thus, the firm does not directly care about the number of workers it employs or the number of apples it produces. It cares only about profit

Arguements for restricting free trade

The job argument: Opponents of free trade often argue that trade with other countries destroys domestic jobs. If a country becomes an importer of cake, then bakers in that country would not be able to keep up with the competitive prices abroad, and would lose domestic costumers to the foreign cake bakers who can make cake more cheaper. But it also creates jobs: When Isolandians buy textiles from other countries, those countries obtain the resources to buy other goods from Isoland. Isolandian workers would move from the textile industry to those industries in which Isoland has a comparative advantage. The transition may impose hardship on some workers in the short run, but it allows Isolandians as a whole to enjoy a higher standard of living. Based on comparative not absolute advantage!!! The national security argument: When an industry is threatened with competition from other countries, opponents of free trade often argue that the industry is vital to national security. For example, if Isoland were considering free trade in steel, domestic steel companies might point out that steel is used to make guns and tanks. Free trade would allow Isoland to become dependent on foreign countries to supply steel. If a war later broke out and the foreign supply was interrupted, Isoland might be unable to produce enough steel and weapons to defend itself. A nation's generals may see things very differently. Indeed, when the military is a consumer of an industry's output, it would benefit from imports. Cheaper steel in Isoland, for example, would allow the Isolandian military to accumulate a stockpile of weapons at lower cost, and thus use the extra money for training or to higher more soldiers. The Infant-Industry Argument: New industries sometimes argue for temporary trade restrictions to help them get started. After a period of protection, the argument goes, these industries will mature and be able to compete with foreign firms. Similarly, older industries sometimes argue that they need temporary protection to help them adjust to new conditions. Economists are often skeptical about such claims, largely because the infant-industry argument is difficult to implement in practice. To apply protection successfully, the government would need to decide which industries will eventually be profitable and decide whether the benefits of establishing these industries exceed the costs of this protection to consumers. Yet "picking winners" is extraordinarily difficult The Unfair-Competition Argument: A common argument is that free trade is desirable only if all countries play by the same rules. If firms in different countries are subject to different laws and regulations, then it is unfair (the argument goes) to expect the firms to compete in the international marketplace. For instance, suppose that the government of Neighborland subsidizes its textile industry by giving textile companies large tax breaks. The Isolandian textile industry might argue that it should be protected from this foreign competition because Neighborland is not competing fairly. he case for free trade is the same as before: The gains of the consumers from buying at the low price would exceed the losses of the producers. Neighborland's subsidy to its textile industry may be a bad policy, but it is the taxpayers of Neighborland who bear the burden. Isoland can benefit from the opportunity to buy textiles at a subsidized price. The Protection-as-a-Bargaining-Chip Argument: Another argument for trade restrictions concerns the strategy of bargaining. Many policymakers claim to support free trade but, at the same time, argue that trade restrictions can be useful when we bargain with our trading partners. They claim that the threat of a trade restriction can help remove a trade restriction already imposed by a foreign government. For example, Isoland might threaten to impose a tariff on textiles unless Neighborland removes its tariff on wheat. If Neighborland responds to this threat by removing its tariff, the result can be freer trade. The problem with this bargaining strategy is that the threat may not work. If it doesn't work, the country faces a choice between two bad options. It can carry out its threat and implement the trade restriction, which would reduce its own economic welfare. Or it can back down from its threat, which would cause it to lose prestige in international affairs. Faced with this choice, the country would probably wish that it had never made the threat in the first place.

Monopoly versus Competition

The key difference between a competitive firm and a monopoly is the monopoly's ability to influence the price of its output. A competitive firm is small relative to the market in which it operates and, therefore, has no power to influence the price of its output. It takes the price as given by market conditions. By contrast, because a monopoly is the sole producer in its market, it can alter the price of its good by adjusting the quantity it supplies to the market.

Marginal revenue for monopolies is very different from marginal revenue for competitive firms. When a monopoly increases the amount it sells, this action has two effects on total revenue (P × Q):

The output effect: More output is sold, so Q is higher, which tends to increase total revenue. The price effect: The price falls, so P is lower, which tends to decrease total revenue. Because a competitive firm can sell all it wants at the market price, there is no price effect. When it increases production by 1 unit, it receives the market price for that unit, and it does not receive any less for the units it was already selling. That is, because the competitive firm is a price taker, its marginal revenue equals the price of its good. By contrast, when a monopoly increases production by 1 unit, it must reduce the price it charges for every unit it sells, and this cut in price reduces revenue on the units it was already selling. As a result, a monopoly's marginal revenue is less than its price.

internalizing the externality

The use of such a tax is called internalizing the externality because it gives buyers and sellers in the market an incentive to take into account the external effects of their actions. The tax would shift the supply curve for aluminum upward by the size of the tax. If the tax accurately reflected the external cost of pollutants released into the atmosphere, the new supply curve would coincide with the social-cost curve. In the new market equilibrium, aluminum producers would produce the socially optimal quantity of aluminum. this would force the market equilibrium price to move up to socially optimal/efficient price of sales. Additionally, since the market price would reflect the tax on producers, consumers of aluminum would have an incentive to buy a smaller quantity. Can also be to move positive externalities closer to social optimum in the form of subsidies

Wage

The wage adjusts to balance the supply and demand for labor (equilibrium) The wage equals the value of the marginal product of labor (p x mpl) Any event that changes the supply or demand for labor must change the equilibrium wage and the value of the marginal product by the same amount because these must always be equal.

Welfare with and without Price Discrimination

There is not consumer surplus.

cost-benefit analysis

To make this decision, the government might hire a team of economists and engineers to conduct a study, called a cost-benefit analysis, to estimate the total costs and benefits of the project to society as a whole. For a highway, the government must compare the total benefits for all those who would use it to the costs of building and maintaining it.

To minimize average costs

To minimize average costs, set average costs = marginal cost

Profit

Total Revenue - total cost (price minus average total costs) times quantity

world price

We call the price prevailing in world markets the world price. If the world price of textiles is higher than the domestic price, then Isoland will export textiles once trade is permitted. Isolandian textile producers will be eager to receive the higher prices available abroad and will start selling their textiles to buyers in other countries. Conversely, if the world price of textiles is lower than the domestic price, then Isoland will import textiles. Because foreign sellers offer a better price, Isolandian textile consumers will quickly start buying textiles from other countries. If the domestic price is low, the cost of producing textiles in Isoland is low, suggesting that Isoland has a comparative advantage in producing textiles relative to the rest of the world. If the domestic price is high, then the cost of producing textiles in Isoland is high, suggesting that foreign countries have a comparative advantage in producing textiles.

When should a firm enter the market

When price is greater than average total costs

When should a firm shut down in the short run?

When total revenue<Variable Costs When Price<Average Variable Costs

The Relationship between Marginal Cost and Average Total Cost

Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising. Average total cost is like your cumulative grade point average. Marginal cost is like the grade you get in the next course you take. If your grade in your next course is less than your grade point average, your grade point average will fall. If your grade in your next course is higher than your grade point average, your grade point average will rise. The mathematics of average and marginal costs is exactly the same as the mathematics of average and marginal grades. This relationship between average total cost and marginal cost has an important corollary: The marginal-cost curve crosses the average-total-cost curve at its minimum.

Sunk Cost

a cost that has already been committed and cannot be recovered We assume that the firm cannot recover its fixed costs by temporarily stopping production. That is, regardless of the quantity of output supplied (even if it is zero), the firm still has to pay its fixed costs. As a result, the fixed costs are sunk in the short run, and the firm should ignore them when deciding how much to produce. The firm's short-run supply curve is the part of the marginal-cost curve that lies above average variable cost, and the size of the fixed cost does not matter for this supply decision.

monopoly

a firm that is the sole seller of a product without any close substitutes The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it. Causes: Monopoly resources: A key resource required for production is owned by a single firm. Government regulation: The government gives a single firm the exclusive right to produce some good or service. The production process: A single firm can produce output at a lower cost than can a larger number of firms.

Profits

a firm's total revenue minus its total cost

Oligopoly

a market structure in which only a few sellers offer similar or identical products duopoly = two sellers

Prisoner's Dilemma

a particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial

Natural monopoly

a single firm can supply a good or service to an entire market at a lower cost than could two or more firms. natural monopoly arises when there are economies of scale over the relevant range of output. Figure 1 shows the average total costs of a firm with economies of scale. In this case, a single firm can produce any amount of output at the lowest cost. That is, for any given amount of output, a larger number of firms leads to less output per firm and higher average total cost. An example of a natural monopoly is the distribution of water. To provide water to residents of a town, a firm must build a network of pipes throughout the town. If two or more firms were to compete in the provision of this service, each firm would have to pay the fixed cost of building a network. Thus, the average total cost of water is lowest if a single firm serves the entire market.

Nash Equllibirum

a situation in which economic actors interacting with one another each choose their best strategy given the strategies that the others have chosen In this case, given that Jill is producing 40 gallons, the best strategy for Jack is also to produce 40 gallons. Similarly, given that Jack is producing 40 gallons, the best strategy for Jill is also to produce 40 gallons. Once they reach this Nash equilibrium, neither Jack nor Jill has an incentive to make a different decision. A state of economic equilibrium in which if one person was to change their strategy or decision, they wouldn't benefit economically.

Collusion

an agreement among firms in a market about quantities to produce or prices to charge If there is an oligopoly, this is easier Although collusion may benefit people the most, in the end, it is prevented by anti-trust laws.

Fixed Cost

costs that do not vary with the quantity of output produced They are incurred even if the firm produces nothing at all. Conrad's fixed costs include any rent he pays because this cost is the same regardless of how much coffee he produces.

variable costs

costs that vary with the quantity of output produced Costs that change as the firm alters the quantity of output produced. Conrad's variable costs include the cost of coffee beans, milk, sugar, and paper cups: The more cups of coffee Conrad makes, the more of these items he needs to buy.

Average Fixed Cost

fixed cost divided by the quantity of output

Implicit Costs

input costs that do not require an outlay of money by the firm For example, Caroline owns a bakery. Imagine that Caroline is skilled with computers and could earn $100 per hour working as a programmer. For every hour that Caroline works at her cookie factory, she gives up $100 in income, and this forgone income is also part of her costs. The total cost of Caroline's business is the sum of her explicit and implicit costs.

explicit costs

input costs that require an outlay of money by the firm For example, a firm has to pay the wages of its workers and has to pay for flour and sugar — these are costs that a firm pays and then can't use the money that they paid for other costs

Deadweight Loss of Monopoly

net loss to society when a firm uses its market power to restrict output and increase price the socially efficient quantity is found where the demand curve and the marginal-cost curve intersect. The monopolist produces less than the socially efficient quantity of output since maximum profit occurs at a different place in the graph when marginal cost equals marginal revenue.

excludable

people be prevented from using the good

Federal regulation of monopolies

sometimes governments increase competition with anti-trust laws Sometimes the government sets the price a monopoly can sell a good at. There are lots of problems with this, including the fact that a monopoly may choose to exit the market, and then the costumers have no where to buy the good. Because a natural monopoly has declining average total cost, marginal cost is less than average total cost. Therefore, if regulators require a natural monopoly to charge a price equal to marginal cost, price will be below average total cost, and the monopoly will lose money. The government may have to find a way to subsidize the monopoly, and it's hard to pick a fair subsidy, and the government would need to raise money through taxation to pay the subsidy. Secondly, a monopoly would have no incentive to try to reduce costs since if they reduce costs, the government would reduce the subsidy. Sometimes the government operates the monopoly itself rather than letting the firm operate the monopoly. In European countries, government often owns telephone, electric, and water companies.

tariff

tax on imported goods. The economists quickly realize that a tariff on textiles will have no effect if Isoland becomes a textile exporter. If no one in Isoland is interested in importing textiles, a tax on textile imports is irrelevant. The tariff matters only if Isoland becomes a textile importer. Concentrating their attention on this case, the economists compare welfare with and without the tariff. Thus, the tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade. Because the tariff raises the domestic price, domestic sellers are better off, and domestic buyers are worse off.

transaction costs

the costs that parties incur in the process of agreeing to and following through on a bargain Sometimes the interested parties fail to solve an externality problem because of transaction costs

Capital

the equipment and structures used to produce goods and services

Economic Profit

the firm's total revenue minus all the opportunity costs total revenue minus total cost, including both explicit and implicit costs

Marginal product

the increase in output that arises from an additional unit of input the increase in the quantity of output obtained from one additional unit of that input. SO if you hire one additional worker, how many more cookies can you produce? Change of output/production over change of input

marginal product of labor

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

Marginal Cost

the increase in total cost that arises from an extra unit of production the amount that total cost rises when the firm increases production by 1 unit of output Change in total cost/change in total quantity . Average total cost tells us the cost of a typical unit of output if total cost is divided evenly over all the units produced. Marginal cost tells us the increase in total cost that arises from producing an additional unit of output Marginal cost is thus more specific to each increase. Average cost is more specific overall.

factors of production

the inputs used to produce goods and services

value of the marginal product

the marginal product of an input times the price of the output How much is each worker producing for the company If we added another worker, how much money would they make us? This value is equivalent to the demand curve for labor. The equilibrium occurs when Value of the Marginal Product = market wage of workers. the value-of-marginal-product curve is the labor-demand curve for a competitive, profit-maximizing firm.

Economies of Scale

the property whereby long-run average total cost falls as the quantity of output increases

diseconomies of scale

the property whereby long-run average total cost rises as the quantity of output increases

constant returns to scale

the property whereby long-run average total cost stays the same as the quantity of output changes

Diminishing marginal Product

the property whereby the marginal product of an input declines as the quantity of the input increases Notice that as the number of workers increases, the marginal product declines. The second worker has a marginal product of 40 cookies, the third worker has a marginal product of 30 cookies, and the fourth worker has a marginal product of 20 cookies. At first, when only a few workers are hired, they have easy access to Caroline's kitchen equipment. As the number of workers increases, additional workers have to share equipment and work in more crowded conditions. Eventually, the kitchen becomes so overcrowded that workers often get in each other's way. Hence, as more workers are hired, each additional worker contributes fewer additional cookies to total production.

diminishing marginal product of labor

the property whereby the marginal product of an input declines as the quantity of the input increases Thus, when you have a lot of workers, but as you add workers the quantity per worker produced goes down because there are too many cooks in the kitchen.

Production Function

the relationship between the quantity of inputs used to make a good and the quantity of output of that good

game theory

the study of how people behave in strategic situations By "strategic" we mean a situation in which a person, when choosing among alternative courses of action, must consider how others might respond to the action she takes.

Gains from trade

there are winners and losers when a nation opens itself up to trade, but the gains of the winners exceed the losses of the losers. Increased variety of goods. Goods produced in different countries are not exactly the same. German beer, for instance, is not the same as American beer. Free trade gives consumers in all countries greater variety to choose from. Lower costs through economies of scale. Some goods can be produced at low cost only if they are produced in large quantities—a phenomenon called economies of scale. A firm in a small country cannot take full advantage of economies of scale if it can sell only in a small domestic market. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully. Increased competition. A company shielded from foreign competitors is more likely to have market power, which in turn gives it the ability to raise prices above competitive levels. This is a type of market failure. Opening up trade fosters competition and gives the invisible hand a better chance to work its magic. Enhanced flow of ideas. The transfer of technological advances around the world is often thought to be linked to the trading of the goods that embody those advances. The best way for a poor agricultural nation to learn about the computer revolution, for instance, is to buy some computers from abroad rather than trying to make them domestically.

Average Total Cost

total cost divided by the quantity of output

Average Revenue

total revenue divided by the quantity sold Average revenue tells us how much revenue a firm receives for the typical unit sold. This illustrates a general lesson that applies not only to competitive firms but to other firms as well. Average revenue is total revenue (P × Q) divided by the quantity (Q). Therefore, for all types of firms, average revenue equals the price of the good.

Accounting Profit

total revenue minus total explicit cost the firm's total revenue minus only the firm's explicit costs.

Average Variable Cost

variable cost divided by the quantity of output

Oligopoly Characteristics

when firms in an oligopoly individually choose production to maximize profit, they produce a quantity of output greater than the level produced by monopoly and less than the level produced by perfect competition. The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost).

Marginal Revenue

which is the change in total revenue from the sale of each additional unit of output. This result illustrates a lesson that applies only to competitive firms. Total revenue is P × Q, and P is fixed for a competitive firm. Therefore, when Q rises by 1 unit, total revenue rises by P dollars. For competitive firms, marginal revenue equals the price of the good.