Econ 110 Chapters 13-15 Study Guide

Implicit Costs

-The rental income Bob could receive if he chose to rent out his showroom -The salary Bob could earn if he worked as a financial advisor. Definition: is opposed to explicit costs where no actual payment is made to any firm.

True or False: Assuming implicit costs are positive, each of the firms operating in this industry in the long run earns negative accounting profit.

Answer: False

The government has granted the U.S. Postal Service the exclusive right to deliver mail. Is it competitive?

Answer: No, no free entry

Dozens of companies produce plain white socks. Consumers regard plain white socks as identical and don't care who manufactures their socks. Is it competitive?

Answer: Yes, meets all assumptions.

Accounting Profit

Total Revenue minus Total Explicit Costs

Explicit Costs

-The wholesale cost for the guitars that Bob pays the manufacturer. -The wages and utility bills that Bob pays. Definition: refer to all costs that require an outlay of money by the firm.

Competitive industry relies on these assumptions:

1. There must be many buyers and sellers—a few players can't dominate the market. 2. Firms must produce an identical product—buyers must regard all sellers' products as equivalent. 3. Firms and resources must be fully mobile, allowing for free entry into and exit from the industry.

Constant Returns to Scale

A firm experiences constant returns to scale when it can increase production without changing long-run average total cost. In the long run, Ike's Bikes can produce 225 or 300 bikes per month for an average total cost of $20 per bike. Therefore, it experiences constant returns to scale within this range. Graphically, this is seen as the horizontal portion of Ike's LRATC curve.

Diseconomies of Scale

A firm experiences diseconomies of scale when long-run average total cost increases as it increases production. In the long run, Ike's Bikes can produce 300 bikes per month for an average total cost of $20. As Ike's Bikes increases production further, however, the average total cost rises. Therefore, it experiences diseconomies of scale when it produces more than 300 bikes per month. Graphically, this is seen as the upward-sloping portion of Ike's LRATC curve.

Economies of Scale

A firm experiences economies of scale when long-run average total cost falls as it increases production. In the long run, Ike's Bikes can produce 75 bikes per month for an average total cost of $70 per bike, 150 bikes per month for an average total cost of $30 per bike, and 225 bikes per month for an average total cost of $20 per bike. The average total cost stays constant at $20 within the range of 225 to 300 bikes per month and increases when Ike's Bikes produces more than 300 bikes per month. Therefore, it experiences economics of scale when it produces fewer than 225 bikes per month. Graphically, this is seen as the downward-sloping portion of Ike's Bikes's LRATC curve.

When a monopolist switches from charging a single price to perfect price discrimination, it reduces

A. consumer surplus Explanation: Perfect price discrimination describes a situation in which the monopolist knows exactly each customer's willingness to pay and can charge each customer a different price. In this case, the monopolist charges each customer exactly his or her willingness to pay, and the monopolist gets the entire surplus in every transaction. When a monopolist charges a single price, some consumers get positive consumer surplus, therefore the switch to perfect price discrimination reduces consumer surplus.

Natural Monopoly

An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms. A natural monopoly arises when there are economies of scale over the relevant range of output, as is the case with this industry.

Raj opens up a lemonade stand for two hours. He spends $10 for ingredients and sells $60 worth of lemonade. In the same two hours, he could have mowed his neighbor's lawn for $40. Raj has an accounting profit of _____ and an economic profit of ____.

Answer: $50, $10 Explanation:An accountant measures the firm's accounting profit as the firm's total revenue minus only the firm's explicit costs. In this example, revenue is equal to the $60 from selling lemonade, and explicit costs are the $10 in ingredients; therefore, accounting profit is . An economist measures a firm's economic profit as the firm's total revenue minus all the opportunity costs (explicit and implicit) of producing the goods and services sold. The $40 Raj could have earned mowing his neighbor's lawn is an opportunity cost. Economic profit takes this cost into consideration as well and is only

Compared to the social optimum, a monopoly firm chooses

Answer: A quantity that is too low and a price that is too high. Explanation: The monopolist chooses to produce and sell the quantity of output at which the marginal-revenue and marginal-cost curves intersect, which is lower than the socially efficient quantity (found where the demand curve and the marginal-cost curve intersect). Furthermore, the price a monopolist charges is higher than the marginal cost, meaning that there are some consumers who value the good more than the marginal cost (but less than the price) who do not receive the good. The price is therefore too high compared to the social optimum.

The government imposes a $1,000 per year license fee on all pizza restaurants. Which cost curves shift as a result?

Answer: Average Total Cost and Average Fixed Cost Explanation:A license fee is an example of a fixed cost; that is, it does not vary with the level of output. Both average total cost and average fixed cost include fixed costs in their calculations. Therefore, the license fee would cause both of these curves to shift.

A competitive firm maximizes profit by choosing the quantity at which

Answer: Marginal Cost equals the price. Explanation: At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal. Because a competitive firm's output quantity does not affect the price, marginal revenue is always equal to the price, therefore the firm chooses the quantity at which marginal cost equals the price.

A competitive firm's short-run supply curve is its ________ cost curve above its ________ cost curve.

Answer: Marginal and Average variable Explanation: Firms maximize profits by producing the quantity at which marginal revenue is equal to marginal cost. A competitive firm's marginal revenue equals the market price, so for any given price, the profit-maximizing quantity of output is found by looking at the intersection of the price with the marginal-cost curve. That is, a competitive firm's marginal-cost curve determines the quantity of the good the firm is willing to supply at any price. However, if the price is less than the average variable cost in the short run, the firm will shut down and produce zero output. Therefore, a competitive firm's short-run supply curve is its marginal-cost curve above its average-variable-cost curve.

There are hundreds of colleges that serve millions of students each year. The colleges vary by location, size, and educational quality, which allows students with diverse preferences to find schools that match their needs. Is it competitve?

Answer: No, not an identical product.

Two taxi companies serve most of the market in a big city. Consumers don't care which taxi company they take—if they decide it's worth taking a taxi, they flag down the nearest one. Is it competitive?

Answer: No, not many sellers?

In the long-run equilibrium of a competitive market with identical firms, what is the relationship between price, marginal cost, and average total cost?

Answer: P=MC and P=ATC Explanation: At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal. Because a competitive firm's output quantity does not affect the price, marginal revenue is always equal to the price; therefore, the firm chooses the quantity at which marginal cost equals the price. In the long run, if the price is less than the average total cost, the firm chooses to exit (or not enter) the market; if the price is less than the average total cost, the firm enters the market. Therefore, in the long-run equilibrium, price is equal to average total cost.

For a profit-maximizing monopoly that charges the same price to all consumers, what is the relationship between price P , marginal revenue MR , and marginal cost MC ?

Answer: P>MR and MR=MC Explanation: Like a competitive firm, the monopolist's profit-maximizing quantity of output is determined by the intersection of the marginal-revenue curve and the marginal-cost curve, therefore P>MR. Unlike a competitive firm, however, the monopolist's profit-maximizing price is greater than marginal revenue (MR=MC).

Suppose that there is only one provider of a service in a state. Because this provider experiences economies of scale, the government does not want to break it into smaller pieces, but it does want the provider to supply the efficient quantity. Which of the following policy options might most effectively enable the government to achieve its objectives in this situation?

Answer: Regulate the firm's pricing behavior. Explanation:Government-imposed limits on the prices that a monopoly can charge consumers is an example of government regulation of monopoly behavior. This gives firms the incentive to provide the efficient quantity, so governments commonly use this method to deal with natural monopolies.

A firm is a natural monopoly if it exhibits the following as its output increases:

Answer: decreasing average total cost Explanation: An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms due to average total cost decreasing as output increases. For any given amount of output, a larger number of firms leads to less output per firm and higher average total cost.

If a higher level of production allows workers to specialize in particular tasks, a firm will likely exhibit ________ of scale and ________ average total cost.

Answer: economies, falling Explanation:If a higher level of production allows workers to specialize in particular tasks, then the greater the level of output, the lower the average total cost will be. When long-run average total cost declines as output increases, there are said to be economies of scale, as average total cost falls with rising output.

If a profit-maximizing, competitive firm is producing a quantity at which marginal cost is between average variable cost and average total cost, it will

Answer: keep producing in the short run but exit the market in the long run.

Pretzel stands in New York City are a perfectly competitive industry in long-run equilibrium. One day, the city starts imposing a $100 per month tax on each stand. How does this policy affect the number of pretzels consumed in the short run and the long run?

Answer: no change in the short run, down in the long run. Explanation: A monthly tax is an example of a fixed cost, because it does not change with the quantity of output produced. A firm chooses to shut down if the price of the good is less than the average variable cost of production, which does not include fixed costs, so there is no change in the number of pretzels consumed in the short run. In the long run, if the price is less than the average total cost (which includes fixed costs), a firm chooses to exit the market. Because the fixed cost increase will drive some firms' average total costs higher than the price, this will cause firms to exit (and the number of pretzels consumed to go down) in the long run.

The deadweight loss from monopoly arises because

Answer: some potential consumers who forgo buying the good value it more than its marginal cost. Explanation: Deadweight loss is the reduction in economic well-being that results from the monopoly's use of its market power. When a monopolist charges a price above marginal cost, some potential consumers value the good at more than its marginal cost but less than the monopolist's price. These consumers do not buy the good. Because the value these consumers place on the good is greater than the cost of providing it to them, this result is inefficient.

If a monopoly's fixed costs increase, its price will _____, and its profit will _____.

Answer: stay the same, decrease. Explanation: The monopolist's profit-maximizing quantity of output is determined by the intersection of the marginal-revenue curve and the marginal-cost curve. The price it charges is determined by the point on the demand curve that corresponds to this level of output. An increase in fixed costs does not alter the marginal revenue or the marginal cost, therefore it does not affect the optimal level of output or the optimal price. It does, however, cause profit to decrease because profit equals total revenue minus total costs, and fixed costs are a component of total costs.

A perfectly competitive firm

Answer: takes its price as given by market conditions Explanation: Because a perfectly competitive firm is small compared to the world market for the good it produces, it takes the price as given by market conditions. That is, the price a given firm receives for its output does not depend on the quantity the individual firm produces.

Diminishing marginal product explains why, as a firm's output increases,

Answer: the production function gets flatter, while the total cost curve gets steeper. Explanation:The production function shows the relationship between the quantity of inputs and quantity of output. As output increases, so must the quantity of workers. Diminishing marginal product refers to the fact that as the inputs to production increase, the marginal product declines, causing the production function to get flatter as output increases. This also means that each subsequent increase in quantity requires a larger increase in inputs, causing total cost to rise at an increasing rate (that is, get steeper).

A firm is producing 20 units with an average total cost of $25 and marginal cost of $15. If the firm were to increase production to 21 units, which of the following must occur?

Answer:Average total cost would decrease. Explanation: 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. In this case, marginal cost is below average total cost, therefore, average total cost is falling and would decrease if the firm were to increase production to 21 units.

A firm is producing 1,000 units at a total cost of $5,000. If it were to increase production to 1,001 units, its total cost would rise to $5,008. What does this information tell you about the firm?

Answer:Marginal cost is $8, and average total cost is $5 Explanation:Marginal cost tells us the increase in total cost that arises from producing an additional unit of output. In this case, producing one additional unit raises costs by . Average total cost tells us the cost of a typical unit of output if total cost is divided evenly over all the units produced. In this case, total cost divided by the number of units produced is equal to roughly.

True or False: Without government regulation, natural monopolies always earn zero profit in the long run.

False

Consider the relationship between monopoly pricing and price elasticity of demand.

If demand is inelastic and a monopolist raises its price, total revenue would increase and total cost would decrease, causing profit to increase. Therefore, a monopolist will never produce a quantity at which the demand curve is inelastic. Explanation: If the firm produced a quantity for which demand was inelastic, then if the firm raised its price, quantity would fall by a smaller percentage than the rise in price, so revenue would increase. Because costs would decrease at a lower quantity, the firm would have higher revenue and lower costs, so profit would be higher. Thus the firm should keep raising its price until profits are maximized, which must happen on an elastic portion of the demand curve.

Bob's lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for $27 each. His total cost each day is $280, of which $30 is a fixed cost. He mows 10 lawns a day.

In the short run, Bob should not shut down. In the long run, Bob should exit the industry. Explanation:Because Bob's average total cost is $280/10=$28, which is greater than the price, he will exit the industry in the long run. Because fixed cost is $30, average variable cost is $280-30/10=$25, which is less than the price, so Bob will not shut down in the short run.

A local boutique is having a sale on sweaters, but customers are not aware of the sale until they are already in the store. In other words, there is no advertising of the sale other than signs in the back of the store that cannot be seen from the outside. All sweaters are marked as 35% off. Is this price discrimination?

No

Price Discrimination

Price discrimination is the practice of selling the same good at different prices to different types of customers.

Economic Profit

Total Revenue minus (Total Explict Costs + Total Implicit Costs)

Various Measures of Cost

Total cost: Fixed Costs + Variable Costs Average Fixed Cost: Fixed Cost/Quantity Average Variable Cost: Variable Cost/Quantity Average Total cost: Total Cost/Quantity

Single price monopoly

Under single-price monopoly (that is, when the monopolist cannot price discriminate), the monopoly charges a price above its marginal cost, so not all consumers who value the good at more than its marginal cost are able to buy it. Thus, deadweight loss exists and is represented by the triangular area between the demand curve and the marginal cost curve to the right of the quantity produced. Moreover, total surplus is not maximized because the quantity of goods produced is less than the socially efficient quantity.

Last-minute "rush" tickets can be purchased for most Broadway theater shows at a discounted price. They are typically distributed via lottery or on a first-come, first-served basis a few hours before the show. Assume that the theater in question does not hold seats in reserve for this purpose, but rather offers rush tickets only for seats not sold before the day of the performance.

Yes