Core-Econ: Chapter 7: The Firm and its Customers

The slope of the demand curve is the trade-off you are constrained to make, which is:

Marginal rate of transformation (MRT). The rate at which the demand curve allows you to transform quantity into price. You can't raise the price without lowering the Q, because fewer consumers will buy a more expensive product.

What happens if firms set prices above marginal cost?

Market failure and deadweight loss occurs.

When taking an action implies forgoing the next best alternative action, this is the net benefit of the foregone alternative.

Opportunity Cost

Isoprofit curves slope downward at points where P __ MC Isoprofit curves slope upward at points where P __ MC

P > MC P < MC

A change that benefits at least one person without making anyone else worse off.

PAreto Improvement

An allocation with the property that there is no alternative technically feasible allocation in which at least one person would be better off, and nobody worse off.

Pareto efficient

The percentage change in demand that would occur in response to a 1% increase in price. We express this as a positive number. Demand is elastic if this is greater than 1, and inelastic if less than 1.

Price elasticity of demand 𝜀=−(% change in demand/% change in price)

The price minus the marginal cost divided by the price. It is inversely proportional to the elasticity of demand for this good.

Price markup (Inversely proportional to the elasticity of demand)

Closely related to the firm's profit, but is not quite the same thing. Its the difference between the firm's revenue and the marginal costs of every unit, but it doesn't allow for fixed costs, which are incurred even when Q=0.

Producer Surplus

Profit = Producer surplus - __

Profit = Producer surplus - fixed costs.

The difference between the price and the marginal cost. Slope of isoprofit curve = -(P-MC)/Q >

Profit margin = - (Profit Margin/Q)

total cost = total revenue = profit =

TC = unit cost x quantity TR = Price x quantity Profit = Revenue - costs

a price above marginal cost results in market failure. Too little is purchased: there are some potential buyers whose willingness to pay exceeds the marginal cost but falls short of the market price—so they won't buy the good and there is a deadweight loss.

The allocation of the good is pareto ineffecient.

Iso profit curves show what?

The different points that give the same level of total profit. Essentially the firm's indifference curves.

Responsiveness of consumers to a price change is measured by what?

The elasticity of demand, which affects the firm's price and profit margin

If P = AC, then

The firm's economic profit is 0.. So, the AC curve is also the zero-profit curve: it shows all the combinations of Q that give zero economic profit.

An indicator of how much a person values a good, measured by the maximum amount he or she would pay to acquire a unit of the good. If a consumers WTP is higher than the price of the good?

Willingness to pay (WTP) They will buy the good.

since marginal cost is the slope of the cost function and the cost curve gets steeper as Q increases, the graph of marginal cost is..

an upward sloping line. (increasing marginal costs)

Table Represents market demand Q for a good at different prices P. Q|P 100|$270 200|$240 300|$210 400|$180 500|$150 600|$120 700|$90 800|$60 900|$30 1000|$0 Firm's unit cost of production is 60$. Based on this, which is correct: a) at q=100, firm's profit is $20k b) profit-maximizing output is q=400 c) maximum profit that can be attained is $50k d) The firm will make a loss at all outputs of 800 and above

b) at q=400, profit = (180-60)x400 = 48K. 400 = 48k 500 = 45K 300 = 45k

A group of firms that collude in order to increase their joint profits.

cartel

Government policy and laws to limit monopoly power and prevent cartels

competition policy (AKA: Antitrust policy)

Expenditures by a private or public entity to create new methods of production, products, or other economically relevant new knowledge.

research and development

AC = MC

slope = 0.

Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other.

substitutes

If the Average cost curve slopes downwards, what does this mean?

there are decreasing average costs

AC is downward sloping until what happens?

until it intersects with marginal cost and results in upward sloping Average Cost.

Why may a large firm be more profitable than a small firm?

1. Technological Advantages: large-scale production often uses fewer inputs per unit of output 2. Cost Advantages: In larger firms, fixed costs such as advertising have a smaller effect on the cost per unit. And they may be able to purchase their inputs at a lower cost because they have more bargaining power.

Why do firms grow?

1. owners can make more money if they expand. 2. people with money to invest get higher returns from owning stock in large firms 3. employees in large firms are also paid more

Measuring elasticities of demand is useful to policymakers. If the government puts a tax on a particular good, the tax will raise the price paid by consumers, so the effect of the tax will depend on the elasticity of demand: If demand is highly elastic = If a tax causes a large fall in sales = So a government wishing to raise tax revenue should choose to tax products with...

= A tax will cause a large reduction in sales. That may be intentional, as when governments tax tobacco to discourage smoking because it is harmful to health. =It also reduces potential tax revenue. .... Inelastic Demand

Profit = Q(P- (C(Q)/Q)) >

= Q(P-AC)

Which is correct? A) firm's technology exhibits constant returns to scale, doubling the inputs leads to doubling of the output level B) if a firm's tech exhibits decreasing returns to scale, doubling the inputs more than doubles the output level C) Exhibit economies of scale, costs per unit will fall as the firm expands its production D) firm's technology exhibits diseconomies of scale, doubling input leads to doubling of the output level.

A: Constant returns: increasing inputs leads to same proportional increase in output C: Since firm can increase output with less than proportional increase in inputs, its cost per unit will fall.

Average cost = ___/___

Average Cost = Total Cost / Quantity

AC>MC then...

Average cost curve slopes downward

AC<MC

Average cost curve slopes upward

Suppose that in a small town a multinational retailer is planning to build a new superstore. Which of the following arguments could be correct? A) The local protestors argue that the close substitutability of some of the goods sold between the new retailer and existing ones means that the new retailer faces inelastic demand for those goods, giving it excessive market power. B)The new retailer argues that the close substitutability of some of the goods implies a high elasticity of demand, leading to healthy competition and lower prices for consumers. C)The local protestors argue that once the local retailers are driven out, there will be no competition, giving the multinational retailer more market power and driving up prices. D)The new retailer argues that most of the goods sold by local retailers are sufficiently differentiated from its own goods that their elasticity of demand will be high enough to protect the

B: Close substitutability between goods implies competition between providers, which typically results in lower prices. C: If the local retailers are driven out, the multinational will have more market power. It will face less elastic demand, and be able to raise prices without losing customers.

A shop sells 20 hats per week at $10 each. When it increases the price to $12, the number of hats sold falls to 15 per week. Which of the following statements are correct? A) When price increases from $10-$12, demand increases by 25% B) A 20% increase in the price causes a 25% fall in demand C) The demand for hats is inelastic D) The elasticity of demand is approximately 1.25

B: P 10> 12 = 20% increase. Q 20 > 15 = -25% fall. D: E= - (-25%/20%) = 1.25

A Firm's cost of production is $12 per unit of output. If P is the price of the output, Q is the number of units produced, which of the following is correct? A) (Q,P) = (2K,20) is on the isoprofit curve representing the profit level $20K B) (Q,P) = (2k,20) is on a lower isoprofit curve than (Q,P) = (1.2K,24) C) (Q,P) = (2k,20) and (4k,16) are on the same isoprofit curve D) (Q,P) = (5k,12) is not on any isoprofit curve

C: at (2k,20) profit = $16K, at (4k,16) profit = $16K; therefore, these two points are on the same isoprofit curve.

Considering a firm whose unit cost is the same at all output levels. Which of the following are correct? a. Each isoprofit curve depicts the firm's profit for different outputs for a given price of the output good. b. Isoprofit curves can be upward-sloping when at high profit levels. c. Every price-quantity combination lies on an isoprofit curve d. Isoprofit curves slope downward when the price is above the unit cost.

C: you can calculate the profit for any combo of PxQ, and draw an isoprofit curve through it by finding other points that give the same profit. D: If the price is above the unit cost, then if output is increased the price must be lowered to keep profit constant, so isoprofit curve slopes downward.

These occur when doubling all of the inputs to a production process doubles the output. The shape of a firm's long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs.

Constant returns to scale

This problem is about how we can do the best for ourselves, given our preferences and constraints, and when the things we value are scarce.

Constrained choice problem

Measure of the benefits of participation in the market for consumers

Consumer surplus.

Suppose that the unit cost of producing a pound of cereal is $2, irrespective of the level of output. Which of the following statements is correct? A) TC curve is a horizontal straight line B) AC curve is downward sloping C) MC curve is upward sloping D) AC and MC curves coincide

D: Both the average and marginal cost are 2 for all outputs, so the curves representing them coincide.

A loss of total surplus relative to a Pareto-efficient allocation.

Dead-Weight Loss

The curve that gives the quantity consumers will buy at each possible price

Demand Curve

Firm maximizes profit at the tangency point: where the slope of the demand curve (MRT) is equal to the Slope of the isoprofit curve, so that the two trade-offs are in balance:

Demand curve is the feasible frontier, and its slope is the MRT of lower prices into greater quantity sold. The isoprofit curve is the indiffference curve, and its slope is the MRS in profit creation, between selling more and charging more. Profit maximizing point: MRT=MRS

A product produced by a single firm that has some unique characteristics compared to similar products of other firms. What kind of demand curve will a firm selling a differentiated product have?

Differentiated Products Downward-sloping demand curve.

Elasticity is 10: Elasticity is .05:

E is 10: Elastic demand (prices will only fall a little if the firm increases its Q, so firms will gain revenue on the extra car without losing much on the other cars and total revenue will rise; or MR>0) E is .05: Inelastic demand (the firm cannot increase Q without a big drop in P, so MR<0.

Costs of production that do not vary with the number of units produced.

Fixed Costs

A flatter demand curve has a lower slope, indicating higher elasticity. So a steeper demand curve will

Have a higher slope, indicating a lower elasticity

Profit maximized when MR = __ IF MR < __: IF MR > __:

MR = MC IF MR < MC => profits fall is Q rises. IF MR > MC => profits can be increased by increasing Q.

Marginal Cost = ___/___

Marginal Cost = Change in C/Change in Q

The isoprofit curve is your indifference curve, and its slope at any point represents the trade-off you are willing to make between P and Q which is called:

Marginal Rate of Substitution (MRS). You would be willing to substitute a high price for a lower quantity if you obtained the same profit.

The increase in revenue obtained by increasing the quantity from Q to Q + 1.

Marginal Revenue

Demand curve is the feasibility set for isoprofit curves. So, what would the profit-maximizing choice be?

The place where the demand curve is tangent to an isoprofit curve.

If average cost curve slopes upwards

There are increasing average costs

The price elasticity of demand is related to the slope of the demand curve. If the demand curve is quite flat, the quantity changes a lot in response to a change in price, so the elasticity is high. Conversely, a steeper demand curve corresponds to a lower elasticity.

They arent the same thing though, elasticity changes as we move along the demand curve, even if the slope of the demand curve (= -(Change in P/Change in Q)) doesnt.

arises from trade in this market, for the firm and consumers together, and is the sum of consumer and producer surplus.

Total surplus

These occur when doubling all of the inputs to a production process less than doubles the output.

diseconomies of scale: (AKA: decreasing returns)

A firm's revenue minus its total costs (including the opportunity cost of capital).

economic profit.

This occurs when doubling all of the inputs to a production process more than doubles the output. The shape of a firm's long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs

economies of scale (AKA: Increasing returns)

Cost savings that occur when two or more products are produced jointly by a single firm, rather being produced in separate firms.

economies of scope

The effect on total cost of producing one additional unit of output. It corresponds to the slope of the total cost function at each point.

marginal cost

occurs when markets allocate resources in a Pareto-inefficient way.

market failure (ex. DWL = market failure of unexploited gains from trade)

An attribute of a firm that can sell its product at a range of feasible prices, so that it can benefit by acting as a price-setter (rather than a price-taker).

market power

A form of economic profits, which arise due to restricted competition in selling a firm's product.

monopoly rents

A production process in which the long-run average cost curve is sufficiently downward-sloping to make it impossible to sustain competition among firms in this market.

natural monopoly

These exist when an increase in the number of users of an output of a firm implies an increase in the value of the output to each of them, because they are connected to each other.

network economies of scale

Corresponds to zero economic profit and means that the rate of profit is equal to the opportunity cost of capital.

normal profits

The amount of income an investor could have received by investing the unit of capital elsewhere.

opportunity cost of capital