Intermediate Microeconomics Quiz 3 Questions

What is the firm's LR supply curve?

P=min ATC

When is TS maximized?

Perfect Competition when P*=MC=MB of last unit

How does a firm pick the size plant/factory it wants to build?

Pick a Q*, then build plant that minimizes cost for Q*

How are return to scale related to economies of scale?

1) Economies of Scale: IRTS 2) Constant Returns to Scale: No economies of scale 3) Diseconomies of Scale: DRTS

What are 3 reasons why LR cost lower than SR cost?

1) Flexible inputs: Increasing returns to scale 2) Technical progress: Increasing productivity 3) Learning by doing: the productive skills and knowledge that works and manages gain from experience.

What are the properties of of isocost lines?

1) Intercepts: Where isocost lines hit K and L axes depends on TC, w, and r 2) Isocosts that are farther from the origin have higher costs than those closer to the origin 3) The slope of each isocost line is the same -w/r, which depends on the relative prices of the inputs.

What are 3 approaches a firm can choose to minimizing cost? Do we get the same result from each of these approaches?

1) Lowest Isocost Rule: Pick the bundle of inputs where the lowest isocost line touches the isoquant. 2) Tangency Rule: Pick the bundle of inputs where the isoquant is tangent to the isocost line. 3) Last Dollar Rule: Pick the bundle of inputs where the last dollar spent on one input gives as much extra output as the last dollar spent on any other input. Yes, all 3 of these rules gives the same point for a convex isoquant.

What are 2 reasons why we study prefect competition?

1) Many markets are reasonably competitive 2) The ideal

What are the 2 questions a firm must ask in its decision to maximize profits?

1) Output Decision: If the firm produces, what output level, q*, maximizes its profits or minimizes its loss? 2) Shutdown Decision: Is it more profitable to produce q* or to shutdown and produce no output?

Why would a market produce less than the competitive output?

1) Restricting the number of firms 2) High entry/exit 3) Price ceiling 4) Price floor 5) Taxes

What are the properties of a competitive market?

1)Price Taker 2) Large number of buyers and sellers 3) Identical products (perfect substitutes) 4) Full (Perfect) Information

How do we know that perfect competition guarantees that the goods produced are those the most preferred by consumers? If MC=MB, does this mean that no one benefits?

=> D and S tell us. Demand curve reflects the marginal value that consumers attach to each unit they consume, so P is amount of money that people are willing to pay for the final unit they consume. Supply curve tells us the marginal cost (opportunity cost) of producing the good. Equilibrium price in Perfect Competition where marginal cost of last unit produced = marginal benefit consumers get from good. Gains from trade. No, both consumers and producers benefit => measure consumer and producer welfare using consumer and producer surplus.

Where does a firm produce, and how can profit be calculated for a perfectly competitive firm?

A firm produces were MC=MR, profit can be calculated for a PC firm by finding q by maximizing profit and then set MC=MR=P

What is a competitive market?

A market where each firm in the market is a price taker.

Why are there zero economic profits in the LR w/ free entry and exit? Does this mean firms do not make an accounting profit?

Accountant measures out-of-pocket costs but not opportunity costs => accounting profit = opp. costs zero econ profits means no profit above opp. costs.

How is CS affected from a change in price when operating on the elastic portion of the demand curve?

As price rises, CS falls by more, the greater the initial revenues spent on the good (on in elastic portion of demand curve).

How is CS affected from a change in price from an elastic vs. an inelastic demand curve?

As price rises, CS falls by more, the less elastic (steeper) the demand curve.

Does the optimal input mix change as r decreases? Does the slope of the isocost curve change as r decreases? Does the cost of producing 200 units change as r decreases?

As r decreases use less L, more K. Slope of isocost is now steeper, -w/r as r decreases. The cost of producing 200 units falls from $100 to $70.70.

When is it difficult for firms to enter or exit the market?

Barriers to entry

How do changes in prices affect the isocost line and isoquant vs. budget line and indifference curves?

Budget line & indifference curves: when the price of a good changed, the budget was the same with relative price (slope) different, and on new indifference curve. Isocost & Isoquant: when the input price changed, the cost changed, with relative price (slope) different, and on same isoquant.

How to calculate CS mathematically for an individual?

CS ind = area under D ind, above P*, up to Q*

How to calculate CS mathematically for a market?

CS mkt = area under D mkt, above P*, up to Q*

What happens to average cost once the plant is built?

Can only alter variable input (get diminishing MP b/c fixed input)

How can economists measure how consumers benefit from markets or policies?

Consumer Surplus and Marginal willingness to PAY (not accept) (aka marginal value/benefit)

How much will a firm produce?

Pick a level of production that maximizes profits: firm must consider cost and price; Amount it can sell depends on market demand and how other firms behave in market.

What is the primary goal of all firms?

To maximize profit

Why must firms maximize profits?

To not lose money and be driven out of business

What happens to cost and price if firms have access to technological advances?

Cost and price decrease

If firms do not have access to technological advances?

Cost and price increase

Why use consumer surplus rather than utility to measure consumer welfare?

Dollars easy to compare utils not very realistic.

Which is more costly, expanding output in the SR or LR?

Expanding output in the SR is more costly than expanding output in the LR b/c the firm has more flexibility in the LR.

If customers don't know the prices other firms charge?

Firm can raise price and still make sales

How does a firm choose a plant size?

Firm chooses a plant size to maximize long-run economic profit according to expectations of future sales. If too big or too small for level of production in the short-run change size in LR. Profit maximizing quantity is where LRMC crosses P.

What is a firm's short-run supply curve? What is the market short-run supply curve?

Firm's SR supply curve is MC above min AVC. Market is firm's Market SR times# of firms in market.

What are the assumptions about entry & exit for perfect competition? When will firms choose to enter the market? What will happen to the long-run supply and equilibrium price as firms enter the market?

Firms enter market if they believe D > ATC => profit > 0 in LR. As firms enter, SR supply increases, P decreases until zero economic profits (P=ATC), and no more incentive for additional firms to enter.

When will firms choose to exit the market? What will happen to the long-run supply and equilibrium price as firms exit the market?

If P < ATC, then firms making a loss, so some will exit market. Short-run Supply decreases, and P increases for remaining firms. Firms will exit until P = ATC for remaining firms (zero economic profit).

When will a firm shut-down in the LR? Will it continue to operate at a loss?

If P< min ATC => shut down in LR exit market. Continue to operate at a loss between P and min ATC.

What should a firm do if one of the factor prices change? Ie, if the price of K falls?

If price of one factor input falls, such as K, substitute away from now relatively more expensive input L, and towards relatively cheaper input K. Isocost line rotates, and cost changes.

How does a firm choose to produce to maximize profits in the long-run?

In LR, firm produces where set q* where P=MR=MC

How do transactions costs affect the demand curve?

In perfect competition transaction costs are zero thus making demand elastic

What is the shape of the LRAC curve if there are several SRAC curves? If there are many?

LRAC is the smooth and U-shaped, if there are many possible SRAC. LRAC is "envelope" of all SRAC. Scallop-shaped if just a few sized firms smoother as more and more different and size firms are added in.

How is the long-run expansion path related to the long-run cost curve? Long-run average cost?

LREP tells the TC for each Q in the LR cost curve. If the average is found for each of these, then you have your LRAC.

What rule should be used if the isoquant is not smooth or convex (i.e, fixed proportions)?

Lowest Isocost Rule

What kind of price can a firm charge if customers know the prices of other firms?

Market equilibrium price

What is the effect of a specific tax on a representative firm's cost curves? Market supply curve?

Market supply curve shift up and the the left if entire market affected. For one particular firm => P does not change, so firm bears cost of rising input costs, shift all cos curves up.

Do most markets have the characteristics of perfect competition? Are they "competitive"? What do we mean when we say they are competitive?

Most markets have some characteristics of perfect competition because buyers and sellers are price-takers.

If LRAC is the envelope of SRAC, is LRMC the envelope of SRMC?

No

Will LRAC curves always be a straight line.

No; the shape is determined by the production function relationship between output and inputs.

How is the LREP derived? How can the LRAC and LRMC be derived from the LREP?

Optimal combos of K and L on multiple TC curves, then use Q and TC to find LRAC. LRMC = (w*change of L + r*change of K)/ change of q.

How do producers benefit from the existence of a market?

Producer Surplus: supply curve derived from MC curve which is MC curve > or = min AVC => PS=TR-VC or PS=(P-AVC)Q

How can we express profit as a function of quantity?

Profit=TR(Q)-TC(Q) or Profit=(P-ATC)Q

How is the market SR supply curve derived?

SR supply (MC > min AVC) times # of firms.

Why is SRAC u-shaped? Why is LRAC u-shaped?

SR: Fixed input => diminishing MP => rising MC (MC u-shaped in SR b/c DMP) LR: all inputs are variable => economies and diseconomies of scale (MC is u-shaped b/c of economies of scale)

How does the number of firms for the market supply curve differ between the SR and LR?

SR: existing firms supply more or less LR: firms can enter or exist the market

Why do SRAC curves initially slope down, then up? LRAC?

SRAC initially slope down b/c the AFC is downward sloping, then SRAC slope up at higher levels of output b/c diminishing marginal returns. LRAC determined by returns-to-scale pattern and the prices of inputs are constant, U-shaped.

When can a firm minimize its losses by staying open? Shutting down? Do these rules hold in the short-run or long-run.

Shut down: pay FC Stay open; pay FC + VC If Rev > Variable Cost in SR (cover all VC and same FC) => stay open Both versions of the shutdown rule hold for all types of firms in both the short-run and the long-run.

How does the isocost line compare to the budget line?

Slope: The slopes of the isocost lines and budget lines are straight lines that depend of relative prices. One vs. Many: But, consumer has one budget line (depending on income), and firm has many isocost lines. Each isocost line corresponds to a different level of expenditure, depending on quantity it wants to produce.

Does "Learning by Doing" have a different effect on the LRAC curve than Economies of Scale?

Speed increase with practice, first impact by Economies of Scale, then by Learning by Doing. Cumulative Output: Higher quantities in subsequent periods will lead to economies of scale. Producing a given quantity over subsequent periods will lower costs due to learning by doing.

What are examples of markets that are competitive?

Stock Market, Chicago Mercantile Exchange

Why would a market produce more than the competitive output?

Subsidy

What is the cost of producing a given level of output?

TC=wL+rK

What does an isoquant show?

Technologically Efficient (Efficient Production): producing the desired level of output with the least amount of inputs.

Which combination of inputs is also "economically efficient"? What information do we need to know?

The isocost line is economically efficient, minimizing the cost of producing a specified amount of output. The information we need to know is the input prices.

When are all inputs variable? Why do firms adjust inputs in the long run?

The only time that all inputs are variable is before the firm constructs the factory. In the LR, fixed costs are avoidable rather than sunk. In the LR, TC=VC.

How is the isocost line affected if all input prices increase by the same amount?

The slope remains the same but TC increases.

What do we mean by "efficiency"?

Two types: 1) Productive efficiency: achieved when output is produced with the least costly combo of inputs given the available technology. => if firms could produce the same output using fewer resources or could produce more output using same resources, not using resources efficiently. => in LR in perfect competition, ensures firms producing at min. point on LRAC. If not, must either adjust size or leave industry to avoid losses. 2) Allocative efficiency: achieved when firms produce the output that is most preferred by consumers. (emphasizes the choice of goods to be produced and the distribution of these goods among consumers.) Just b/c goods are produced at least possible cost does not ensure that allocation of resources is most efficient one possible. It may be that goods are being produced are not ones customers prefer.

What makes perfect competition so special?

We use perfect competition as a benchmark for evaluating the efficiency of markets.

What do we mean by "welfare"? How can society's welfare be measured?

Welfare: well-being of a group (not payments to poor people). Society's welfare = Total Surplus = Total Welfare = CS +PS

Why does producing less than the competitive output lower welfare?

When MB>MC resources are being used ineffeciently

Why does producing more than the competitive output lower welfare?

When MC >MB resources are being used ineffeciently

Is the Chicago Mercantile Exchange an example of perfect competition?

Yes

Why are firm's LR profit also zero when there are limited inputs/ limited entry?

Zero econ profits b/c pay extra profit as rent