Managerial Econ - Test 2

Normal good vs inferior good

normal good = increase in income leads to increase in Q demanded for a good inferior good = increase in income leads to a decrease in Q demanded for a good (bologna, bus travel, and generic jeans )

in the Linear Production function, inputs are what?

perfect substitutes

Cost minimization

producing output at the lowest possible cost MRTS KL = w/r (the absolute value of the slope of the isoquant reflects the marginal rate of technical substitution and that the slope of the isocost line is given by -w/r)

Decreasing (diminishing) marginal returns

range of input usage over which marginal product declines

Increasing marginal returns

range of input usage over which marginal product increases

Negative marginal returns

range of input usage over which marginal product is negative

Total cost

sum of fixed and variable costs

How do you get an individual demand curve for a normal good from an indifference curve?

take the initial equilibrium point and then change the price of the good x (shifting the curve outward to the new price) -- come down straight with both the originial point and the new point after changing the price of good x and connect the dots (income and the price of good Y are held constant)

What is one important property of consumer equilibrium?

that at the equilibrium consumption bundle, the slope of the indifference curve is equal to the slope of the budget line. recall, the absolute value of the slope of the indifference curve is called Marg. rate of substitution and the slope of the budget line is given by -Px/Py

If bundle A lies ON the budget line, what does that mean?

that the combo of goods X and Y completely exhaust the consumer's income

If there were no scarcity, what would the more-is-better property imply?

that the consumer would want to consume bundles that contained infinite amounts of goods. However, one implication of scarcity is that the consumer MUST select a bundle that lies inside the budget set, that is, an affordable bundle.

The slope of the budget line is -Px / Py. This also represents what?

the MARKET RATE OF SUBSTITUTION between goods X and Y.

If consumer's income remains fixed at M and the price of good Y remains unchanged, but the price of good X decreases, what happens to the budget line?

the budget line's slope will change b/c the slope = -Px / Py the reduction in price of good X will make the slope/line flatter than before. Since the max. amount of good Y that can be purchased is M/Py, a reduction in the price of good X does NOT change the Y intercept budget line. the ultimate effect is to rotate the budget line counterclockwise. similarly, an increase in the price of good X (income and price of good Y remaining unchanged), will cause a clockwise rotation of the budget line.

Marginal rate of substitution (MRTS)

the rate at which a producer can substitute between two inputs and maintain the same level of output MRTS KL= MPL/MPK

The market rate of substitution

the rate at which one good may be traded for another in the market; the slope of the budget line change y / change x

If prices of goods X and Y remain the same, but income (M) increases, what happens to the budget line?

the slope of the budget line, -Px/Py, does not change with a change in income but the vertical and horizontal intercepts of the budget line both increase as the consumer's income increases (b/c more of each good can be purchases at the higher income). the budget line will shift to the right in a parallel fashion if income increases. the budget line will shift to the left in a parallel fashion if income decreases

Define the 'short-run'

the time frame in which there are fixed factors of production

What is the budget line?

If a consumer spends ALL of his/her income on goods x and y, the budget line can depict the combinations of goods x and y that exactly exhaust a consumer's income.

What does completeness refer to?

It is to say that for any two bundles, A > B or B > A or A ~ B; it is the assumption that the consumer is capable of expressing a preference for, or indifference among, all bundles. *If the consumer cannot express her or his own preference for or indifference among goods, the manager can hardly predict that individual's consumption pattern with reasonable accuracy.

Marginal Cost for Cubic Costs function

MC(Q) = a + 2bQ + 3cQ^2

What is the equation for consumer equilibrium?

MRS = Px / Py -if this condition did not hold, the personal rate at which the consumer is willing to substitute between goods X and Y would differ from the market rate at which he or she is able to substitute between the goods

For the Leontief production function, there is no what?

MRTS b/c there is no substitution among inputs along an isoquant.

What is the opportunity set aka the budget set notation?

PxX + PyY is less than or equal to M where M = income PxX = price of good X and PyY = price of good y

IF a consumer spent their entire income on good X, the expenditures on good X would exactly equal the consumer's income -- what is the equation?

PxX = M

IF the consumer spent their entire income of good Y, then the expenditures on good Y would exactly equal income in what equation...

PyY = M

What is the budget line notation?

(Px / Py)X + Y = (M/Py) so, if we solve for Y (slope-intercept form), we get Y = (M/Py) - (Px/Py)X

What are the 4 properties that the preference ordering (ex: bundle A being preferred to bundle B aka (A > B) ) is assumed to satisfy?

1- completeness 2- more is better 3- diminishing marginal rate of substitution 4- transitivity

What is the manager's role in guiding the production process? (2 parts)

1- to ensure that the firm operates on the production function 2- to ensure that the firm uses the correct level of inputs

What is the slope of the budget line equation Y = (M/Py) - (Px/Py)X ? What is the vertical intercept?

-Px / Py M/Py

What types of constraints are there?

-legal -time -physical -budget

Cost Function

-valuable b/c if provides essential info a manager needs to determine the profit-max. level of output -cost funct. summarizes info about the production process and thus reduces the amnt. of info the manager has to process to make optimal output decisions.

When characterizing consumer behavior, there are what 2 important factors to consider?

1- Consumer opportunities 2- Consumer preferences

What are the three most important measures of productivity that are useful for evaluating the effectiveness of a production process and for making input decisions that max. profits?

1- total product 2- average product 3- marginal product

What does the 3rd property of preference ordering, the diminishing rate of marginal substitution, refer to?

As a consumer obtains more of good X, the amount of good Y he / she is willing to give up to obtain another unit of x decreases. *this assumption implies that the indifference curves are the convex shape from the origin.

Curves father or close to the origin imply higher levels of satisfaction?

Curves FARTHER from the origin

What does 'more is better' refer to?

Ex: if Bundle A has at least as much of every good as bundle B and more of some good, bundle A is preferred to bundle B. If more is better, the consumer views the products under consideration as "goods" instead of "bads" -this assumption provides important info about consumer preferences, but it does NOT help us to determine a consumer's preference for all possible bundles, so more assumptions are needed to draw up the indifference curve(s).

What does the 4th property of preference ordering, Transitivity, refer to?

For any three bundles ( A, B, C) --> if A > B and B >C, then A > C. Similarly, if A ~ B and B ~C, then A ~ C this assumption, along with more is better, implies that the indifference curves do NOT intersect one another. It also eliminates the possibility that the consumer is caught in a perpetual cycle in which she/he never makes a choice.

The TOTAL effect of a price increase is composed of substitution and income effects. The substitution effect reflects what? The income effect results from what?

Substitution effect reflects a movement along an indifference curve, thus isolating the effect of a relative price change on consumption. Income effect results from a parallel shift in the budget line; thus, it isolates the effect of reduced "real income" on consumption.

What is the objective of the consumer ?

To choose a bundle that will max. his/her utility or satisfaction.

If we manipulate the equation PxX = M to get the max. affordable Q of good X, the equation is.....

X = M / Px ---> this is the horizontal intercept of the budget line

If we manipulate the equation PyY = M to see the max. affordable Q of good Y that is affordable, the equation is...

Y = M / Py

Which yields higher utility: a cash gift or an In-Kind Gift?

a cash gift b/c the the in-kind gift may not have been what the consumer would have purchased if they were given the cash in place of the gift.

Sunk cost

a cost that is forever lost after it has been paid; the amount of theses fixed costs that cannot be recouped **irrelevant to decision making where maximizing profits and minimizing losses are concerned

Indifference curve

a curve that defines the combinations of two goods (x and y) that give a consumer the same level of satisfaction; that is, the consumer is indifferent between any combination of goods along an indifference curve. *all combos of goods x & y along an indifference curve give the consumer the same level of satisfaction

Long-run cost curve

a curve that defines the minimum ave. cost of producing alternative levels of output, allowing for optimal selection of both fixed and variable factors of production.

multi-product cost function

a function that defines the cost of producing given levels of two or more types of outputs assuming all inputs are used efficiently.

Production function

a function that defines the maximum amount of output that can be produced with a given set of inputs Q = F ( K, L ) where Q = the man. quantity that can be produced with inputs K & L K = capital (machines of some sort) L = labor (people)

Short-run cost function

a function that defines the min. possible cost of producing each output level when variable factors are employed in the cost-minimizing fashion.

Why is the "buy one, get one free" marketing scheme different from the "half price" sale?

a half-price sale cuts the price of each and every unit in half. The buy one, get one free deal does not change the relative price of any units between 0 and 1 unit AND it also makes the price of units purchased between 1 and 2 units purchased zero.

Isocost line

a line that represents the combinations of inputs that will cost the producer the same amount of money. *different combos of capital and labor end up costing the firm the same amount - wL + rK = C w=wage rate r= the rental rate (the price of capital)

Average product (AP)

a measure of the output produced per unit of input APL = Q/ L --> average product of labor APk= Q/ K ---> average product of capital

Linear Production function

a production function that assumes a perfect linear relationship between all inputs and total output Q = F(K,L) = aK + bL where a, b are constants ex: it takes workers at a plant 4 hours to produce what a machine can make in one hour. the linear production function where a = 4 and b = 1 is: Q = F ( K,L) = 4K + L this is stating that capital is always 4 times more productive as labor.

Cobb-Douglas production function

a production function that assumes some degree of substitutability among inputs. Q = F ( K,L) = K^a * L^b a, b are constants the relationship between output and inputs is not linear. the inputs need not be in fixed proportions SO: MPL = bK^aL^b-1 AND: MPK= aK^a-1L^b

Leontief Production Function aka the fixed-proportions production function

a production function that assumes that inputs are used in fixed proportions Q = F ( K,L) = min (aK, bL) where a,b are constants *implies that inputs are used in fixed proportions -- exs: one shovel for one worker as two shovels for one worker would not do any good for that worker ex2: the keyboards and keyboarders - only 1 keyboarder can produce one paper. any additional keyboards are only useful if there are more keyboarders to use them

Law of Diminishing Marginal Rate of Technical Substitution

a property of a production function stating that as less of one input is used, increasing amounts of another input must be employed to produce the same level of output.

Vertical integration

a situation where a firm produces the inputs required to makes its final product.

In the short run, managers can adjust their use of inputs such as labor - this type of input is called what?

a variable factor of production

Consumer

an individual who purchases goods & services from firms for the purpose of consumption.

Why is the Leontief Isoquant 'L' shaped?

b/c it implies that the inputs must be used in fixed proportions; the manger cannot substitute between capital and labor and maintain the same level of output.

Why is the isoquant graphically convex?

b/c the inputs of labor and capital typically are not perfectly substitutable as it takes increasing amounts of labor to replace each unit of capital that is taken away.

Changes in input prices do what to the isocost lines?

changes the slopes of the isocost lines

Cubic Cost Function

costs are a cubic function of output; provides a reasonable approx. to virtually any cost function C(Q) = f + aQ + bQ^2 + cQ^3

transaction costs

costs associated with acquiring an input that are in excess of the amount paid to the input supplier

Variable costs VC(Q)

costs that change with changes in output; include the costs of inputs that vary with output

Fixed costs FC

costs that do not change with changes in output; include the costs of fixed inputs used in production

What is often associated with in-kind gifts?

dead-weight loss

Average fixed costs ___________ as output is expanded

decline *this difference between average total and average variable costs diminishes as fixed costs are spread over increasing levels of output.

Isoquant

defines the combinations of inputs (K , L ) that yield the same level of output; that is, any combination of capital and labor along an isoquant produces the same level of output

Economies of scale

exist when long-run ave. costs decline as output is increased

Diseconomies of scale

exist when long-run ave. costs rise as output is increased.

In the short run, some factors of production are what?

fixed - b/c it is harder in the short run to make changes to capital (ex: it takes years to acquire new machines )

short-run total costs

fixed and variable costs

Average fixed cost

fixed costs divided by the number of units of output AFC = FC / Q

For given input prices, isocosts farther from the origin are associated with what?

higher costs

Should you ignore sunk costs when trying to max. profits or min. losses?

ignore

What is the primary advantage of indifference curve analysis?

it allows a manager to see how price changes affect the mix of goods that consumers purchase in equilibrium.

What is a budget set ?

it defines the combinations of goods X and Y that are affordable for the consumer: The consumer's expenditures on good X, plus his/her expenditures on good Y do not exceed the consumer's income.

How do you derive a market demand curve from an indifference curve?

it is the horizontal summation of individual demand curves and it indicated the total quantity all consumers in the market would purchase at each possible price. (see page 151)

What is the budget constraint?

it is the restricting factor of consumer behavior by forcing the consumer to select a bundle of goods that is affordable to them.

What does receiving cash do to a consumer's budget line?

it shifts it outward in a parallel fashion, the slop remains unchanged

The consumer's opportunity set depends on what?

market prices and the consumer's income - so as these parameters change, so does the opp. set.

Marginal product (MP)

the change in total output attributable to the last unit of input MPk= change Q / change K --> marg. product of capital MPL = change Q / change L ---> marg. product of labor

What does the SHAPE of the indifference curve depend on?

the consumer's preferences ---> one way to summarize info about consumer's preferences is in terms of marginal rate of substitution.

Marginal (incremental) cost (MC)

the cost of producing an additional unit of output MC = change C / change Q **most important cost concept

A change in the price of a good will lead to a change in what?

the equilibrium consumption bundle

Consumer Equilibrium

the equilibrium consumption bundle is the affordable bundle that yields the greatest satisfaction to the consumer ---the consumer will have no incentive to change to a different affordable bundle once the equil. point is reached

Define the 'long-run'

the horizon over which the manager can adjust all factors of production

What is the difference between the Law of Diminishing Marginal Returns and the Law of Diminishing Marginal Rate of Technical Substitution?

the law of diminishing marg. returns is the decline in marginal productivity experienced when input usage increases, holding all other inputs constant. In contrast, the law of diminishing marg. rate of tech. substitution is a property of a production function stating that as less of one input is used, increasing amounts of another input must be employed to produce the same level of output.

Total Product (TP)

the max. level of output that can be produced w/a given amount of inputs

Substitution effect

the movement along a given indifference curve that results from a change in the relative prices of goods, holding real income constant. *reflects how a consumer will react to a different market rate of substitution

Income effect

the movement from one indifference curve to another that results from the change in real income caused by a price change. *reflects the fact that when a price increases, the consumer's "real income" falls. if the good with the increased price is a normal good, the reduction in income leads to a further reduction in the consumption of X.

What is 'Marginal Rate of Substitution'?

the rate at which a consumer is willing to substitute one good for another good and still maintain the same level of satisfaction. *the absolute value of the slope of the indifference curve.

Value marginal product

the value of the output produced by the last unit of an input. Value marginal product of labor: VMPL = P x MPL Value marginal product of capital: VMPK = P x MPK

What is consumer preferences?

they determine which of these goods will in fact be consumed

What is consumer opportunities?

they represent the possible goods & services consumers can afford to consume.

Profit-Maximizing Input Usage

to max. profits, a manager should use inputs at levels at which the marg. benefit equals the marg. cost. More specifically, when the cost of each add'l unit of labor is w, the manager should continue to employ labor up to the point where VMPL= w in the range of diminishing marginal product.

Optimal Input Substitution

to min. the cost of producing a given level of output, the firm should use less of an input and more of other inputs when that input's price rises.

Average total cost

total cost divided by the number of units of output; provides a measure of total costs on a per-unit basis ATC = C(Q) / Q

Average variable costs

variable cost divided by the number of units of output AVC = VC(Q) / Q

cost compliementarity

when the marginal cost of producing one type of output decreases when the output of another good is increased.

economies of scope

when the total cost of producing two types of outputs together is less than the total cost of producing each type of output separately. ex: a restaurant selling both steak and chicken dinners rather than having two restaurants one selling just chicken dinners and one selling just steak dinners.

Income changes and consumer behavior can predict what about the goods?

whether the goods are normal or inferior