Econ 201 (Final)
what costs do firms consider in the short run?
Firms consider variable and fixed costs and marginal costs. They also consider the AVC, AFC, and ATC
How do competitive markets work?
Firms in competitive markets sell similar products. Firms are also free to enter and exit the market whenever they wish. The price and quantity produced are determined by market forces instead of by the firm.
when does diminishing marginal product occur?
It will occur in the any short run production process at the point at which additional units of a variable input no longer generate as much output as before.
what does Marginal Cost determine?
MC is the key variable in determining a firm's cost structure. The MC curve aways leads the ATC and AVC curves up or down.
How is a competitive market different from a monopoly?
Many firms, cannot earn long run economic profit, has no market power (price taker), produces an efficient level of output (because P=MC).
Characteristics of Competitive Markets
Many sellers, Similar products, Free entry and exit, Price taking, every firm is small.
What is price discrimination?
Occurs when firms can identify different groups of customers with varying price elasticities of demand and can prevent resale among their customers.
How is a monopoly different from a competitive market?
One firm, may earn long run economic profits, has significant market power (price maker), produces less than the efficient level of output (P>MC).
Characteristics of Monopolies
One seller, A unique product without close substitutes, High barriers to entry and price making
What does the supply curve look like in a perfectly competitive market?
Profits and losses act as signals for firms to enter or leave a market. As a result, perfectly competitive markets drive economic profit to zero in the long run.
How is price discrimination practiced?
Some consumers pay a higher price and other receive a discount. It is profitable for the firm, reduces DWL, and leads to a higher output level.
scale
The size of the production process
what costs do firms consider in the long run?
These costs are a reflection of scale. Firms can experience diseconomies of scale, economies of scale or constant returns to scale, depending on the industry.
How much do monopolies charge, and how much do they produce?
They are price makers who may earn long-run economic profits. They use the profit maximization rule as well.
What does the entry and exit of firms ensure?
They ensure that the market supply curve in a competitive market is much more elastic in the long run than the short run.
third-party problem
a situation in which those not directly involved in a market activity experience negative or positive externalities
economies of scale
condition occurring when long-run average costs decline as output expands
constant returns to scale
condition occurring when long-run average costs remain constant as output expands
diseconomies of scale
condition occurring when long-run average costs rise as output expands
diminishing marginal product
condition occurring when successive increases in inputs are associated with a slower rise in output
market failure
condition occurring when there is an inefficient allocation of resources in a market
How are costs broken up?
explicit costs, easy to calculate and implicit costs, hard to calculate. economic profit accounts for implicit costs and is always less than the accounting profit.
signals
information conveyed by profits and losses about the profitability of various markets
what is diminishing marginal product?
it is a result of fixed inputs (such as capital and land) in the short run.
monopoly power
measure of a monopolist's ability to set the price of a good
Explicit costs are called _____ costs and implicit costs are _____ costs.
out-of-pocket; opportunity
free-ride problem
phenomenon occurring when someone receives a benefit without having to pay for it
accounting profit
profit calculated by subtracting a firm's explicit costs from total revenue
economic profit
profit calculated by subtracting both the explicit and the implicit costs of business from a firm's total revenue
private property
provision of an exclusive right of ownership that allows for the use, and especially the exchange of property
internalize
relating to a firm's handling of externalities, to take into account the external costs (or benefits) to society that occur as a result of the firm's actions
barriers to entry
restrictions that make it difficult for new firms to enter a market
marginal product
the change in output associated with one additional unit of an input
external costs
the costs of a market activity imposed on people who are not participants in that market
internal costs
the costs of a market activity paid only by an individual participant
implicit costs
the costs of resources already owned, for which no out-of-pocket payment is made
externalities
the costs or benefits of a market activity that affect a third party.
tragedy of the commons
the depletion of a good that is rival in consumption but non-excludable
how to calculate marginal cost
the difference of total cost over the difference of quantity
factors of production
the inputs (labor,land and capital) used in producing goods and services.
efficient scale
the output level that minimizes ATC in the long run
perfect price discrimination
the practice of selling the same good or service at a unique price to every customer
price discrimination
the practice of selling the same good or service at different prices to different groups
social optimum
the price and quantity combination that would exist if there were no externalities
output
the product that the firm creates
production function
the relationship between the inputs a firm uses and the output it creates
loss
the result when total revenue is less than total cost
profit-maximizing rule
the rule stating that profit maximization occurs when a firm chooses the quantity of output that causes marginal revenue to be equal to marginal cost, or MR=MC
natural monopoly
the situation that occurs when a single large firm has lower costs than any potential smaller competitor
social costs
the sum of the internal costs and external costs of a market activity
profit
the total result when revenue is higher than total cost
Coase theorem
theorem stating that if there are no barriers to negotiations and if property rights are fully specified, interested parties will bargain to correct externalities.
how should firms maximize profit?
they must effectively combine land, labor and capital in the right quantities
how much should a firm produce?
they should produce an output that is consistent with the largest possible economic profit.
sunk costs
unrecoverable costs that have been incurred as a result of past decisions
rent seeking
using resources to secure monopoly rights through the political process
In the long run, costs are
variable only
Billy Bob runs a seafood restaurant. Last year he earned $50,000 in revenue. He had explicit costs of $20,000. Billy Bob could have made $30,000 working for the county and could have received an additional $20,000 if he rented out his building and equipment. Calculate Billy Bob's implicit costs.
$50,000-FEEDBACK: Implicit costs are the opportunity costs of doing business. Billy Bob's implicit costs include the salary he could have made working for the county ($30,000) and the money he could have received in rent for his building and equipment ($20,000). Therefore, Billy Bob's total implicit costs equal $20,000 + $30,000 = $50,000.
Billy Bob runs a seafood restaurant. Last year he earned $50,000 in revenue. He had explicit costs of $20,000. Billy Bob could have made $30,000 working for the county and could have received an additional $20,000 if he rented out his building and equipment. Calculate Billy Bob's economic profit.
-$20,000-FEEDBACK: Use the equation for economic profit: economic profit = total revenues - (explicit costs + implicit costs). We know that Billy Bob's explicit costs are $20,000. Billy Bob's implicit costs are the salary he could have made working for the county ($30,000) plus the money he could have received if he had rented out his building and equipment ($20,000). Inserting these values into the equation for economic profit, we get, economic profit = $50,000 - ($20,000 + $30,000 + $20,000) = -$20,000.
How are monopolies created?
A market structure characterized by a single seller that produces a well-defined product with no good substitutes. They operate in a market with high barriers to entry, the chief source of the market power. They are created when a single seller supplies the entire market for a particular good or service.
how are profits and losses calculated?
By calculating the difference between total cost and total revenue
How do firms maximize profits?
By expanding output until MR=MC.
What are the problems with a monopoly?
Charges too much, and produces too little. The monopolist's output is smaller than the output that would exist in a competitive market, leading to DWL. The gov grants of monopoly power encourage rent seeking, or the use of resources to secure monopoly rights through the political process.
explicit costs
tangible out-of-pocket expenses
what does the Total Cost function represent?
TC(q) represents the total cost to a firm producing q
How to find total cost
TC=FC+VC
FC
The amount of cost that is fixed regardless how much the firm produces -Rent -Start up machinery
VC
The amount of cost that varies with production -Labor -Raw Materials
AFC
The average fixed cost is an amount determine by dividing a firm's TFC by the output
ATC
The average total cost is the sum of AVC and AFC
AVC
The average variable cost is an amount determined by dividing a firm's TVC by the output
P>ATC
The firm makes a profit
ATC>P>AVC
The firm will operate at a minimize loss
AVC>P
The firm will temporarily shut down
What are the solutions with a monopoly?
The gov may break up firms that gain too much market power in order to restore a competitive market. They can also promote open markets by reducing trade barriers. The gov can also regulate a monopolist's ability to charge excessive prices.
MC
The marginal cost is the increase in cost that occurs from producing one additional unit of output
MR
The marginal revenue is the change in total revenue a firm receives when it produces one additional unit of output
price taker
a firm with no control over the price set by the market
price maker
a firm with some control over the price it charges
public good
a good that can be jointly consumer by more than one person, and from which non payers are difficult to exclude
rival good
a good that cannot be enjoyed bemire than one person at a time
excludable good
a good that the consumer must purchase before having access to it
private good
a good with two characteristics: it is both excludable and rival in consumption
club good
a good with two characteristics: it is nontrivial in consumption and excludable
common-resource good
a good with two characteristics: it is rival in consumption and non excludable
cost-benefit analysis
a process that economists use to determine whether the benefits of providing a public good outweigh the costs.
cap and trade
an approach used to curb pollution by creating a system of emissions
property rights
an owner's ability to exercise control over a resource
variable costs
costs that change with the rate of output
fixed costs
costs that do not vary with a firm's output in the short run; also known as overhead
total cost
the amount a firm spends to produce and/or sell goods and services
2 types of profit
economic and accounting. if a business ha an economic profit, its revenue is larger than the combination of its explicit and implicit costs.
Firms producing an identical product in a competitive market are producing at a level of output that maximizes profit. The current market price is $4.50 per unit and the firms are producing at a long-run average cost of $3.50 per unit. Over the long-run one should expect
entry of new firms into this market. FEEDBACK: New firms will enter a market in the long run if there is an incentive for them to do so. In this scenario, firms are producing at a long-run average cost of $3.50 and receiving a price of $4.50. Because price is greater than long-run average total cost (P LRATC), new firms will find it profitable to enter the market.
Converse, an apparel company, has been fairly successful selling denim-colored college sportswear. Lydia sees an opportunity for profit and enters the market. After producing her profit maximizing level of output, she finds that her average total cost per unit is $40, her average variable cost per unit is $30, and the market price is $35. In the short run, Lydia should
stay in business even though she is suffering a loss. FEEDBACK: To answer this question, you need to be familiar with the shut-down rule in the short run. If the price is less than average total cost but greater than average variable cost, then the firm will operate to minimize loss. This is the scenario presented here: since price ($35) is less than average total cost ($40) and greater than average variable cost ($30), Lydia should stay in business even though she is suffering a loss.
