Unit 3 Microeconomics

Variable Cost

-a cost that depends on the qty of output produced -a cost that changes as output produced changes -cost of the variable input

Net Gain

Net Gain = MR - MC -When (+) the producer's profit will increase -When (-) the producer's profit will decrease

Marginal Product

the marginal product of an input is the additional qty of output produced by using one more unit of that input

Break Even Price

the market price at which it earns zero profits for a price taking firm

Implicit Cost

does not require an outlay of money; it is measured by the value, in dollar terms, of benefits that are forgone.

Principle of Marginal Analysis

every activity should continue until marginal benefit equals marginal cost.

Team Spirit

(or lack thereof) usually declines as production gets to be on a larger scale; as a result, production usually decreases

Oligopoly

- few firms—more than one but not a large number—sell products that may be either identical or differentiated -imperfect competition -the result of the same factors that sometimes produce a monopoly, but in somewhat weaker form

Optimal Output Rule

-Profit is maximized by producing the qty of output at which MR = MC -If there is no pt at which MR = MC, the producer should produce until one more unit would cause marginal benefit to fall below marginal cost

Marginal Cost Curve

-Slopes upward due to diminishing returns to the inputs (as output increases, the marginal product of the variable input declines. More of the variable input must be used to produce each additional unit of output as the amount of output already produced rises.) -Slopes downward as a firm increases its production from 0 to some low level, than slopes upward only at higher levels of production -The MC curve initially decreases and then increases due to the principle of diminishing marginal productivity.

Price-Taking Consumer

-a consumer whose actions have no effect on the market price of the good or service he or she buys. -the market price is unaffected by how much or how little of the good the consumer buys

Fixed Cost

-a cost that does not depend on the qty of output produced -acost that does not change, regardless of output produced -cost of the fixed input -"overhead cost"

Sunk Costs

-a cost that has already been incurred and is nonrecoverable -should be ignored in a decision about future actions.

Price-Taking Firm

-a firm whose actions have no effect on the market price of the good or service it sells. -takes the market price as given

Price-Taking Firm's Optimal Output Rule

-a price-taking firm's profit is maximized by producing the quantity of output at which the market price is equal to the marginal cost of the last unit produced -for a price-taking firm, the additional revenue generated by producing one more unit is always the market price

Monopoly

-a single firm sells a single, undifferentiated product. -protected by barriers to entry -

Short Run

-a situation where the firm can only change 1 of its inputs to production and must keep all other inputs fixed (usually labor in micro)

Perfectly Competitive Industry

-an industry in which firms are price-takers.

Fixed Input

-an input whose quantity is fixed for a period of time and cannot be varied -there are no fixed inputs in the long run

Marginal Revenue

-change in total revenue generated by an additional unit of output.

Diminishing Returns to an Input

-exist when an increase the qty of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input -results in the MPL having a negative slope -results in each successive unit of an input raising production by less than the last unit if the qty of all other inputs is held fixed

Patent

-gives an inventor a temporary monopoly in the use or sale of an invention -most countries lasts between 16 and 20 years.

Economies of Scale

-when long-run average total cost declines as output increases. -encourages firms to grow in size -can result from increasing returns to scale CAN ARISE FROM 1) increased specialization of workers- workers become more skilled and efficient --> increasing returns to scale 2) initial setup costs 3) network externalities

Diseconomies of Scale

-when long-run average total cost increases as output increases. -limits the size of firms -can result from decreasing returns to scale CAN ARISE FROM: 1) issues with communication, organization-as a firm grows in size, it becomes ever more difficult and therefore costly to communicate and to organize activities.

Free Entry and Exit

-when new firms can easily enter into the industry and existing firms can easily leave the industry -no obstacles in the form of government regulations or limited access to key resources prevent new firms from entering the market -no additional costs are associated with shutting down a company and leaving the industry. -ensures that firms in an industry cannot act to keep other firms out

Decreasing Returns to Scale

-when output increases less than in proportion to an increase in all inputs

Increasing Returns to Scale

-when output increases more than in proportion to an increase in all inputs ex: doubling inputs would cause your outputs to more than double

2 Questions of Production

1) "Should I Produce at all?" 2) If yes to #1, "How much?" (the qty at which MR = MC)

Profit

P = TR - TC

Implicit cost of capital

The opportunity cost of the capital used by a business—the income the owner could have received from that capital if it had been used in its next best alternative way. ex: renting/selling machines & investing that money, which would earn interest. The interest is implicit cost of capitol

Imperfect Competition

When no one firm has a monopoly, but producers nonetheless realize that they can affect market prices ex: Oligopoly & monopolistic competition

Variable Input

an input whose quantity the firm can vary at any time

Marginal Revenue Curve

shows how marginal revenue varies as output varies.

Average Total Cost (Average Cost)

-"Average Cost" -total cost divided by qty of output produced -equal to total cost per unit of output -the sum of the avg fixed cost and the avg variable cost -as qty of output increases, ATC falls, then rises ATC = TC/ Q

Economic Efficiency

-"productive efficiency" -The method that produces a given level of output at the lowest possible cost

Short- Run ATC

-A company that has to increase output suddenly to meet a surge in demand will typically find that in the short run its average total cost rises sharply because it is hard to get extra production out of existing facilities. But given time to build new factories or add machinery, short-run average total cost falls. -When output is low, the increase in fixed cost from the additional equipment outweighs the reduction in variable cost from higher worker productivity—that is, there are too few units of output over which to spread the additional fixed cost.

Short-Run Individual Supply Curve

-As long as the market price is equal to or above the shut-down price, the firm will produce the qty of output at which MC = P. So at market prices equal to or above the shut-down price, the firm's short-run supply curve corresponds to its MC curve. -At any market price below the minimum AVC, the firm shuts down and output drops to zero in the short run. This corresponds to the vertical segment of the curve that lies on top of the vertical axis.

Perfect Competition Profitability and Production Conditions

-Fixed Cost plays no role in the decision about whether to produce in the short-run or not -A perfectly competitive firm maximizes profit, or minimizes loss, by producing the quantity that equates price and marginal cost. -The exception is if price is below minimum average variable cost in the short run, or below minimum average total cost in the long run, in which case the firm is better off shutting down.

When is Production Profitable?

-If the firm produces a quantity at which P > ATC, the firm is profitable. -If the firm produces a quantity at which P = ATC, the firm breaks even. -If the firm produces a quantity at which P < ATC, the firm incurs a loss. -In the short run a firm will maximize profit by producing the quantity of output at which MC = MR.

Changes in Fixed Cost

-In the long run the level of fixed cost is a matter of choice, and a firm will choose the level of fixed cost that minimizes the average total cost for its desired output level. -changes in fixed cost that cause short-run average total cost curves to differ from long-run total cost curves -In the long run, a firm can always eliminate fixed cost by selling off its plant and equipment. If it does so, of course, it can't produce any output—it has exited the industry.

U-Shaped Average Total Cost Curve

-falls at low levels of output and then rises at higher levels -the norm for firms in many industries -U-shaped because ATC is the sum of the AFC & AVC, which work in opposite directions as output rises -The MC curve initially decreases and then increases due to the principle of diminishing marginal productivity. Because marginal costs play a significant role in the shape of the ATC curve, this is also the reason as to why the ATC curve initially decreases and then increases forever on thereafter.

Copyright

-gives the creator of a literary or artistic work the sole right to profit from that work -usually for a period equal to the creator's lifetime plus 70 years

Exit/ Entry in the Long Run

-in the long run firms will exit an industry if the market price is consistently less than their break-even price—their minimum average total cost. -if the price is consistently above the break-even price, for an extended period of time, the firm is profitable, and will remain in the industry and continue producing. -If the price is high enough to generate profits for existing producers, it will also attract some of these potential producers into the industry. So in the long run a price in excess of the ATC should lead to entry. -exit and entry lead to an important distinction between the short-run industry supply curve and the long-run industry supply curve

Inputs to Production

-items that contribute to the production of a final good -labor, marchines, raw materials, land/buildings

Monopolistic Competition

-many firms -differentiated products (consumers see these competing products as close substitutes) -free entry & exit in the long run -common in service industries such as the restaurant and gas station industries ex: producers of economics textbooks

Perfect Competition

-many firms each sell an identical product. -price-taking firms -price-taking consumers -The supply and demand model is a model of a perfectly competitive market. -the demand curve is a horizontal line at the market price -no firms have large market shares -free entry & exit

Concentration Ratios

-measures the percentage of industry sales accounted for by the "X" largest firms - 4 firm concentration ratio - 8 firm concentration ratio ex: Let's say that the largest four firms account for 25%, 20%, 15%, and10% of industry sales, then the four-firm concentration ratios would equal 70 (25+20+15+10)

Total Product Curve

-shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input -slope = marginal product of labor -position of the curve depends on the qty of other inputs -Like TCC, it slopes upward due to increasing variable cost (the more output produced, the higher the business's total cost)

Total Cost Curve

-shows how total cost depends on the qty of output -Like TPC, it slopes upward due to increasing variable cost (the more output produced, the higher the business's total cost) -Unlike TPC, the slope becomes steeper due to diminishing returns to the variable input

Long-Run Average Total Cost Curve (LRATC)

-shows the relationship between output and ATC when FC has been chosen to minimize ATC for each level of output -"U" Shaped -a firm will find itself on one of its short-run cost curves, the one corresponding to its current level of fixed cost; a change in output will cause it to move along that curve. If the firm expects that change in output level to be long-standing, then it is likely that the firm's current level of fixed cost is no longer optimal. Given sufficient time, it will want to adjust its fixed cost to a new level that minimizes average total cost for its new output level.

Total Cost

-sum of the fixed cost and the variable cost TC = FC + VC

Average Fixed Cost

-the fixed cost per unit of output -falls as more output is produced because the numerator (FC) is a fixed #, but the denominator (qty) increases as more output is produced, resulting in a smaller #. -The AFC curve is downward sloping and approaches zero due to the fact that fixed costs don't change, and as quantity increases, you have a fixed amount that is being divided by a larger and larger denominator, which means that the AFC curve will approach zero (this is also known as the "spreading effect" according to the text) AFC = FC/Q

Market Share

-the fraction of the total industry output accounted for by that firm's output.

The Diminishing Returns Effect

-the larger the output, the greater the amount of variable input required to produce additional units, leading to higher AVC -at high levels of output, the diminishing returns effect dominates the spreading effect, causing the ATC curve to slope upward.

The Spreading Effect

-the larger the output, the greater the qty of output over which FC is spread, leading to lower AFC -at low levels of output, the spreading effect dominates the diminishing returns effect & causes the ATC curve to slope downward

Minimum-Cost Output

-the quantity of output at which average total cost is lowest -At the minimum-cost output: ATC = MC -At output less than the minimum-cost output: MC < ATC and ATC is falling -At output greater than the minimum-cost output: MC > ATC, and ATC is rising

Herfindahl-Hirschman Index (HHI)

-the square of each firm's share of market sales summed over the industry. It gives a picture of the industry market structure -Unlike concentration ratios, the HHI takes into account the distribution of market sales among the top firms by squaring each firm's market share, thereby giving more weight to larger firms ex: if an industry contains only 3 firms and their market shares are 60%, 25%, and 15%, then... HHI = 602 + 252 + 152 = 4,450

Average Variable Cost

-the variable cost per unit of output -rises as more output increases because of diminishing returns to the variable input. (each additional unit of output adds more to VC than the previous unit because increasing amounts of the variable input are required to make another unit) -AVC curve slopes upward due to diminishing returns -when graphed, AVC is flatter than the MC curve because the higher cost of an additional unit of output is average crossed all units, not just the additional unit -"Swoosh Shape" AVC = VC/Q

Normal Profit

-when economic profit = zero -means that the firm could not do any better using its resources in any alternative activity. -It is an economic profit just high enough to keep a firm engaged in its current activity

Marginal "Anything"

= A change in total "anything" given a change in quantity

Total "Anything"

= Average "anything" x quantity

Average "Anything"

= Total "anything"/quantity

Marginal Cost

= slope of the total cost curve -The change in total cost given a change in quantity -shows how the cost of producing one more unit depends on the quantity that has already been produced. -higher marginal cost = steeper slope -"Swoosh Shape" because when a firm starts w/ a small # of workers, employing more workers & expanding output leads to specialization, which increases returns to hiring additional workers, which results in a MC curve that slopes downward. Once there are enough workers to exhaust the benefit of further specialization, diminishing returns to labor set in and the MC curve begins to slope upward. MC = (delta)TC/(delta)Q

Point M

= the minimum ATC (minimum-cost output) -where the spreading effect and the diminishing returns effect balance each other

Shut-Down Price

A firm will cease production in the short run if the market price falls below the shut-down price, which is equal to minimum average variable cost. -When price is greater than minimum average variable cost, however, the firm should produce in the short run. -This means that whenever price falls between minimum average total cost and minimum average variable cost, the firm is better off producing some output in the short run. -When the market price is below the minimum average variable cost, the price the firm receives per unit is not covering its variable cost per unit. A firm in this situation should cease production immediately.

Indivisible Setup Costs

Costs in which a certain minimum amount of production must be undertaken before the input is economically feasible to use Ex: If a transportation firm purchases an 18-wheeler, would it be economically feasible to transport one box?

Long Run Cost Curve

Economies of Scale: -occur in the beginning stages of production, when long-run average total costs decrease as output increases -occur because of indivisible setup costs Constant Returns to Scale: -occur when long-run ATC do not change with an increase in output (can occur when production techniques can be replicated again and again) Diseconomies of Scale: -occur when long-run ATC increases as output increases -occur because of monitoring costs and lack of team spirit

Interpreting Perfect Competition Graphs

Profit = (P − ATC) × Q Loss = (ATC − P) x Q -Whenever the market price exceeds the minimum average total cost, there are output levels for which the average total cost is less than the market price. They will achieve the highest possible profit by producing the quantity at which marginal cost equals price. -if the market price is less than the minimum average total cost, there is no output level at which price exceeds average total cost. As a result, the firm will be unprofitable at any quantity of output.

Equation for Profit

Profit = TR-TC The primary goal of most firms is to maximize profit

Accounting Profit

TR - explicit cost - depreciation

Economic Profit

TR - opportunity cost( implicit & explicit costs) -when economists use the simple term profit, they are referring to economic profit -If a business' economic profit is (-), the business should close & the owner should devote their time and capital to something else -(+) economic profit indicates that the current use is the best use of resources. -(-) economic profit indicates that there is a better alternative use for resources.

Total Revenue

TR = P x Q

Explicit Cost

a cost that involves actually laying out money.

Standardized Product (Commodity)

a good that consumers regard the product of a different firm as the same good ex: apples

Production Function

constituted by the relationship between the qty of labor and qty of output, for a given amount of the fixed input

Monitoring Costs

costs incurred by the organizer of production in seeing to it that employees are doing what they are supposed to do

Long Run Decisions

firms will look at all production technologies and choose the ones that are the most economically efficient (the lowest cost)

Differentiated Goods

goods that are different but considered at least somewhat substitutable by consumers ex: Coke vs. Pepsi

Barrier to Entry

something that prevents other firms from entering the industry 4 TYPES: 1) Control of a Scarce Resource or Input - controls a resource or input crucial to an industry can prevent other firms from entering its market 2) Economies of Scale - when large fixed costs are required to operate, a given quantity of output is produced at lower average total cost by one large firm than by two or more smaller firms (ex: natural gas industry) 3) Technological Superiority -A firm that maintains a consistent technological advantage over potential competitors can establish itself as a monopolist -Network Externalities --> the firm possessing the largest network—the largest number of consumers currently using its product—has an advantage over its competitors in attracting new customers, an advantage that may allow it to become a monopolist 4) Government-Created Barriers - law allows a monopoly to exist temporarily by granting property rights that encourage invention and creation (ex: patents & copyrights)

Production Function

the relationship between the quantity of inputs a firm uses and the quantity of output it produces

Long Run

the time period in which all inputs can be varied

Constant Returns to Scale

when output increases directly in proportion to an increase in all inputs.

Network Externalities

when the value of a good to a consumer rises as the number of other people who also use the good rises