Econ Exam #2

What are economic profits at a firm's break-even point?

0

Using your own words, explain why economic profit is much more relevant to decision-making in a business than accounting profit. (This is a key understanding. Make sure you can do it.)

A business that earns an accounting profit has revenues that are greater than the costs than it must explicitly pay now or in the future. However, that does not mean that it is earning an actual profit. It may be able to earn even larger accounting profits in another similar business. If it can, then those larger accounting profits that it could earn elsewhere are actual costs. Thus, it is giving up its explicit costs plus a large implicit cost (the profits it could earn elsewhere), which together are greater than its revenues. It is losing in very real terms. If the business used the concept of economic profits, then it should decide to leave its current business.

monopolistic competition

A market structure in which many companies sell products that are similar but not identical (differentiated products)

Oligopoly

A market structure in which only a few sellers offer similar or identical products

Barriers to entry

Any impediment that makes it difficult or impossible for a new firm to enter and compete in a market

Why do some summer resort hotels stay open in the winter, even if they are not earning profits? Why do some close?

As long as variable costs can be covered, the owners will earn something to help reduce the fixed costs from the rest of the year.

Average Revenue

Average amount received per unit, the total revenue divided by the number of goods sold

What are economic losses? Can a firm earn accounting profits and economic losses at the same time? Explain.

Earning economic losses means that a firm is earning less than normal profits. Thus, if most firms earn a profit of 15 percent of sales and this particular firm is earning 5 percent, it is earning an accounting profit of 5 percent and an economic loss of 10 percent. That is, it is earning 10 percent less than it could earn if it were a typical business.

Marginal revenue is only positive when demand is

Elastic. We established in previous chapters that when consumers are on the elastic portion of their demand curve, if the price is lowered, revenue would increase. So, if the firm is producing where marginal revenue is positive, it must be producing on the elastic portion of the demand curve.

What are examples of perfectly competitive markets?

Fishing boats all catching and selling the same fish at a market.

If a firm has fixed costs, why should it stop producing when its marginal revenue is less than its average variable cost?

If the income from producing a good is greater than the additional cost of producing when compared with not producing, the firm is better off producing. But if the firm adds to losses by producing, the firm should not produce at all.

A campus charity is raising funds for a local homeless shelter. One of the members of the board comes up with an idea to sell bagels on the terrace outside the student center. Would this effort be profitable?

In answering the question, costs of the bagels and any other inputs should be considered and subtracted from the revenues. That provides a measure of accounting profits. However, the real question that needs to be asked next is, what could the students have done with their time? If they could have earned even more for the charity in holding a fundraising drive, then that amount really needs to be subtracted from the accounting profits to get a measure of the true profits - that is, the economic profits.

Why can't a single firm in a perfectly competitive industry influence the market price?

Its production level is too small to affect the market

Monopoly

Market with only one firm

What is the assumed primary goal of competitive firms?

Maximization of profits (given the market and the firms resources, the firm wants to select a rate of output, levels of input, and prices that will provide the highest possible profits for the firm.

Do competitive firms have control over prices?

No, because so many other firms are producing identical goods. So, customers will just go elsewhere.

Can a monopoly be allocativley efficient

No. That means that prices are equal to marginal costs and consumers are maximizing their own satisfaction. We cannot be better off with different levels of production.

What is a competitive firm?

One with many other firms producing identical goods.

Why do barriers to entry allow a monopolist to make positive economic profits?

Otherwise, firms would enter the market, resulting in a decrease in price and profits.

In perfect competition, the demand curve for an individual firms product is..?

Perfectly Elastic because the demand curve is horizontal since the firm has no control over the price.

Accounting profits at a firm's economic profit break-even point are ________.

Positive

Consider a perfectly competitive firm. When the market price is greater than both the firm's marginal cost and average variable cost, the firm

Should increase its level of output.

Marginal Revenue

The change in total revenue as a firm sells one more unit of a good or service.

Why is there an upward-sloping marginal cost curve?

The firm experiences diminishing marginal product in the short run. With lower marginal product comes higher marginal costs.

Do monopolies have control over prices.

They have influence, but not total influence because as prices increase, the quantity demanded will decrease as customers will switch to other goods and services.

Why is it profitable to operate a run-down hotel with a low cost of maintenance and probably low revenues? Would it not be better to improve the conditions in the hotel and attract more customers?

To fix up the hotel will cost something. A comparison of that improvement cost with the increase in revenues from the higher room rates will give the answer. If the room rates do not increase sufficiently to cover the repair and improvement costs, then it makes no sense to improve the run-down hotel

Total Revenue

Total amount received as firms sell their products. The number of goods sold times the price at which they are sold

Assuming costs are below market price, where should you produce?

Where MR=MC.

n your own words, explain why a firm should produce where marginal revenue is equal to marginal cost (or as close to equal as possible).

Your answer should discuss how if marginal revenue is greater than marginal cost, then profits increase as quantity increases. If marginal revenue is less than marginal cost, then profits are decreasing as quantity increases. The point where marginal revenue is equal to marginal cost occurs when profits are maximized.

Explicit costs

cost that a business pay buy writing a check or paying in cash. When a firm has to directly pay for something

Markets of perfectly competitive firms and monopolies both _________.

have downward slanting slopes. so, as price decreases quantity increase.

In the long run, a monopolist facing the same cost curves as a perfectly competitive firm will charge a ______________ price than the competitive market and produce a ______________ output.

higher, lower. The perfectly competitive firms, in the long run, will produce where marginal cost and average cost are just equal to the market price. The monopolist will find that at that level of production, marginal revenue will be much less than the marginal cost. Thus, the monopolist will raise the price and produce less.

perfectly competitive market

many buyers and sellers all producing the same product. All are aware of quality and prices. Firms can easily enter and exit industry.

Normall profit

opportunity cost of capital and other inputs supplied by the owners of a business.

implicit cost

profit owners could earn in an alternative business. forgone alternatives that were not a direct payment.

allocative efficiency

right amount of a good or service is being produced - marginal utilities per dollar of resource used are all equal

economic profit

total revenue minus total cost, including both explicit and implicit costs.

accounting profits

total revenues minus explicit profits. To an economist, if a firm is earning accounting profits just equal to what the average firm earns, it is not actually earning a profit. That is a zero economic profit

3 examples of explicit costs

wages, raw materials, rent

opportunity cost

what could be purchased with the payments for the factors of production in the accounting profit calculatio