EC201 Exam 3 and Final
Firms with monopoly power are
"Price searchers"
Producers in competitive markets are called
"Price takers"
Xavier opens up a lemonade stand for two hours. He spends $10 for ingredients and sells $60 of lemonade. In the same two hours, he could have mowed his neighbor's lawn for $40. Xavier has an accounting profit of _____ and economic profit of _____.
$50, $10
Suppose that for most consumers of alcoholic beverages there is no close substitute product. Which of the following figures would most likely represent the short-run elasticity of demand for alcoholic beverages?
-0.25. Goods with few close substitutes tend to be goods with relatively inelastic demands.
The fundamental relationship
Cost and productivity are inversely related
Under what conditions will a firm exit a market? Explain.
A firm will exit a market if the revenue it would get from remaining in business is less than its total cost. This occurs if price is less than average total cost.
Under what conditions will a firm shut down temporarily? Explain.
A firm will shut down temporarily if the revenue it would get from producing is lower than the variable costs of production. This occurs if price is less than average variable cost.
Explain the difference between the firm's revenue and its profit. Which do firms maximize?
A firm's total revenue equals its price multiplied by the quantity of units it sells. Profit is the difference between total revenue and total cost. Economist typically model firm behavior under the assumption that firms are trying to maximize profit.
Monopoly resources
A key resource required for production is owned by a single firm
An exit refers to
A long-run decision to leave the market
Suppose the price elasticity of demand for Dog Chow is -0.80, and there is a 6.0% decrease in the price of Dog Chow. Ceteris paribus, it follows that total revenues from Dog Chow sales would _____ as a result of the decrease in the price of Dog Chow.
Decrease. By definition, a good with an inelastic demand will see, in absolute value terms, a decrease in price mathematically overwhelm the resulting increase in quantity demanded: |%ΔQ|<|%ΔP|; thus total revenue will decrease in this case.
Natural gas is used in the generation of residential electrical power. Suppose that natural gas producers develop a new technology for the production of natural gas. It follows that, ceteris paribus, the price of natural gas will _____; while the price of residential electricity will ______.
Decrease; decrease.
Suppose your economist tells you that sushi is a normal good; whereas Spam is an inferior good. Further suppose that your economist predicts there will be no recession in 2017, and consumer incomes will increase by 2.67%. Ceteris paribus, it follows that the price of sushi will _______; whereas the price of Spam will ______.
Increase; decrease
What is the relationship between a firm's total revenue, profit, and total cost?
The relationship between a firm's total revenue, profit, and total cost is profit equals total revenue minus total costs
Production function
The relationship between the quantity of inputs used to make a good and the quantity of output of that good
The firm exits the market if
The revenue it would get from producing is less than its total cost
Total cost is
The sum of implicit and explicit costs
The firm shuts down if
The revenue that it would earn from producing is less than its variable costs of production
Marginal cost
The change in a firm's total cost from producing one more unit of a good or service
The socially efficient quantity is found where
The demand curve and the marginal-cost curve intersect
The demand curve facing a monopolist is
The entire downward sloping market demand curve
Implicit costs
Input costs that do not require an outlay of money by the firm
When the government imposes a binding price ceiling, it causes a ______; when it imposes a binding price floor it causes a _____.
Shortage; surplus
The deadweight loss from monopoly arises because
Some potential customers who forgo buying the good value it more than its marginal cost.
Because a firm's marginal-cost curve determines the quantity of the good the firm is willing to supply at any price, the marginal-cost curve is also the competitive firm's
Supply curve
A perfectly competitive firm
Takes its price as given by market conditions
Profit-maximizing quantity is found where
The MC = MR
Refer back to the problem where the demand for X is given by: P = 60 - 2X; and the supply for X is given by P =30 - X. The equilibrium price is $40 and the equilibrium quantity is 10. In the market for X, the consumer surplus is ______ and the producer surplus is _______.
100; 50. CS = ((60 - 40)x10)/2 = 100; PS = ((40-30)x10)/2 = 50
Which of the following offers the best example of a "public good"?
The United States Navy. - To be a public good, a good must be non-rival and non-excludable - i.e. people cannot be excluded from its consumption.
Total revenue
The amount a firm receives for a sale of its output
Price discrimination
The business practice of selling the same good at different prices to different customers
Although economists often argue about how to categorize specific goods in goods in terms of whether or not they are public goods, club goods, and so forth, ceteris paribus, it is safe to categorize goods that are non-excludable and rival as __________, and goods that are excludable and non-rival as ____________.
Common resources; club goods
______ is a _____ variable; whereas, _______ is a ______ variable.
Consumer income, demand-side; the price of productive inputs, supply-side.
Fixed costs
Costs that do not vary with the quantity of the output produced
Variable costs
Costs that vary with the quantity of output produced
Rule of Reason doctrine
Courts must evaluate a firm's behavior in acquiring monopoly power- ie some behavior is "reasonable", other behavior is not
Suppose your economist tells you the "free-market" demand for X is given by: P = 60 - 2X; and the "free-market" supply of X is given by P = 20 + 2X. Ceteris paribus, the equilibrium quantity exchanged in this market is _____, and consumer surplus is _____.
10; 200. This follows from the equilibrium: just set P=P and solve for X and P. X=10 and P=40. Thus the consumer surplus is: ((60-40)x10)/2=100.
Refer back to the problem where the demand for X is given by: P = 60 - 2X; and the supply for X is given by P =30 - X. Suppose the supply of X changed and became P = 15 + X. It follows the new consumer surplus would be _____, and the new producer surplus would be _____, ceteris paribus.
225; 112.50. CS = ((60 - 30)x15)/2 = 225; PS = ((30-15)x15)/2 = 112.50
Suppose your economist tells you the demand for X is given by: P = 60 - 2X; and the supply for X is given by P =30 - X. Ceteris paribus, the equilibrium price of X is ____, and equilibrium quantity exchanged is _____.
40; 10. Demand: P=60-2X; and supply: P=30+X. Set P=P and solve for X: 60-2X=30+X; or X=10. Now plug X back into both equations to obtain P: 60-2(10)=40; 30+10=40.
Suppose your economist tells you the demand for X is given by: X = 60 - 5P; and the supply of X is given by X = 11 + 2P. Ceteris paribus, the equilibrium price of X is _____, and equilibrium quantity exchanged is _____.
7; 25. Demand: X=60-5P; and supply: X=11+2P. Set X=X and solve for P: 60-5P=11 + 2P; or P=7. Now plug P back into both equations to obtain X: 60-5(7)=25; 11+2(7 )=25.
Monopolistic competition
A bunch of firms have a little bit of monopoly power, like with brand names
Sunk cost
A cost that has already been committed and cannot be recovered
Which of the following diagrams illustrates the change in the equilibrium in the market for airline tickets as a result of a decrease in the price of crude petroleum (an input in the production of aviation fuel)?
A decrease in the price of a productive input leads to an increase in supply and a decrease in the market price, ceteris paribus.
In the market for wheat bread, which of the following would cause the equilibrium price of wheat bread to decrease and the equilibrium quantity exchanged to increase?
A decrease in the price of flour
Suppose copper roofing is a key input in the production of new homes. Further suppose copper miners successfully unionize, and thus obtain an increase in their average wages. Ceteris paribus, which of the following will be the most likely impact of the success of the miners' union?
A decrease in the supply of new homes and an increase in the equilibrium price. An increase in the price of a productive input leads to a decrease in supply and an increase in the market price, ceteris paribus.
Refer back to the problem where the supply of X was changed. Ceteris paribus, which of the following would most likely lead to the change noted in the question?
A decrease in the wages and salaries of workers who produce X. A decrease in the price of productive inputs used to produce X will increase the supply of X, which will in turn decrease the price of X (e.g. from 40 to 30) and increase the consumption of X (e.g. from 10 to 15).
Stock
A financial security that represents partial ownership of a firm
Monopoly
A firm that is the sole seller of a product without any close substitutes
Competitive market
A market with many buyers and sellers trading identical products so that each buyer and seller is a price taker
Which of the following is most likely to be considered a good with positive externalities?
A municipal police department. If the police department deters crime, then the probability that you will be the victim of a crime is reduced, whether you pay taxes or not.
Compared to the social optimum, a monopoly firm chooses
A quantity that is too low and a price that is too high
A shutdown refers to
A short-run decision not to produce anything during a specific period of time due to current market conditions
Refer to the problem where the "free-market" demand for X is given by: P = 60 - 2X; and the "free-market" supply of X is given by P = 20 + 2X. Suppose the government imposes a price ceiling of P = 20. It follows that the ceiling will generate:
A shortage greater than 10 units of X. To find the shortage - i.e. gap between the quantity supplied and the quantity demanded - just plug the ceiling price, $20, into the supply function and obtain the quantity supplied, which is zero; then do the same for the demand function, which will yield a quantity of 20. Thus the shortage is QD - QS = 20.
The production process
A single firm can produce output at a lower cost than can a larger number of firms
Natural monopoly
A type of monopoly that arises because a single firm can supply a good or service to an entire market at a lower cost than could two or more firms
Law of diminishing returns
Adding more of a variable input to the same amount of a fixed input will cause the marginal product of the variable input to decline
Define natural monopoly. What does the size of a market have to do with whether an industry is a natural monopoly?
An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
At the profit-maximizing level of output, marginal revenue and marginal cost
Are equal
The government imposes a $1,000 per year license fee on all pizza restaurants. As a result, which cost curves shift?
Average total cost and average fixed cost
Bob's lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for $27 each. His total cost for each day is $280, including $30 fixed cost. He mows 10 lawns a day. What can you say about Bob's short-run decision regarding shutdown and his long-run decision regarding cost?
Bob's total variable cost is his total cost each day less his fixed cost ($280 - $30 = $250). His average variable cost is his total variable cost each day divided by the number of lawns he mows each day ($250/10 = $25). Because his average variable cost is less than his price, he will not shut down in the short run. Bob's average total cost is his total cost each day divided by the number of lawns he mows each day ($280/10 = $28). Because his average total cost is greater than his price, he will exit the industry in the long run, unless market conditions become more favorable.
If consumers often purchase muffins to eat while they drink their lattes at local coffee shops, what would happen to the equilibrium price and quantity of muffins if the price of lattes increases, ceteris paribus?
Both the equilibrium price and quantity would decrease.
In the long run, any price below the ATC is
Cause for going out of business
Suppose a federal excise tax, to be collected by sellers, is placed on cell phones. Further suppose the market for cell phones is characterized by a downward sloping demand curve and an upward sloping supply curve. Ceteris paribus, it follows that the quantity of cell phones exchanged, after the imposition of the tax, will _____, and the net price received by sellers, i.e. the price they received after they pay the tax, will _____.
Decrease; decrease
Suppose the market for pepperoni pizzas is characterized by a downward sloping demand curve and an upward sloping supply curve. Now suppose an excise tax, to be collected by pizza sellers, is imposed on this market. Ceteris paribus, it follows that the consumer surplus will ____, and the producer surplus will _____.
Decrease; decrease. The tax wedge squeezes both consumer surplus and producer surplus, and it creates a deadweight loss.
Suppose there is a decrease in the price of herbicides and pesticides used in the production of barley. Ceteris paribus, the equilibrium price of barley will _______, and equilibrium quantity exchanged will ________.
Decrease; increase. A decrease in the price of productive inputs used to produce X (in this case barley) will increase the supply of X, which will in turn decrease the price of X and increase the consumption of X.
Suppose ballet tickets are a normal good; whereas matinee movie tickets are an inferior good. Further suppose your economist tells you that consumer incomes are expected to decrease by 2.09% during calendar year 2017. Ceteris paribus, it follows that the price of ballet tickets will _____; whereas the price of matinee movie tickets will _______.
Decrease; increase. By definition, an inferior good (e.g. matinee movie tickets) is one the demand for which varies inversely with income - i.e. lower incomes lead to an increase in demand, and an increase in demand increases price and the quantity exchanged. Conversely, by definition, a normal good (ballet ticket) is one the demand for which varies positively with income - i.e. lower incomes lead to a decrease in demand, and a decrease in demand decreases price and the quantity exchanged.
If marginal cost is below AVC, AVC
Decreases
A firm is a natural monopoly if it exhibits the following as its output increases:
Decreasing average total cost
Clayton Antitrust Act
Deemed illegal those practices, the effect of which was "to lessen competition, or to tend to create monopoly", including horizontal integration, tying arrangements, and interlocking directorates
Yield
Dividend*4/closing price
The marginal revenue curve is
Downward sloping
Define economics of scale and explain why they might arise. Define diseconomies of scale and explain why they might arise.
Economies of scale exist when long-run average total cost decreases as the quantity of output increases, which often occurs because of specialization among workers. Diseconomies of scale exist when long-run average total cost rises as the quantity of output increases, which occurs because of the coordination problems inherent in a large organization.
If a higher level of production allows workers to specialize in particular tasks, a firm will likely exhibit _____ of scale and _____ average total cost.
Economies, falling
Give an example of a government-created monopoly. Is creating this monopoly necessarily bad public policy? Explain.
Examples of government-created monopoly include patent and copyright laws. Both allow firms or individuals to be monopolies for extended periods of time—20 years for patents, the life of the author plus 70 years for copyrights. But this monopoly power is good, because without it, no one would write a book or a song and no firm would invest in research and development to invent new products or pharmaceuticals
A monopoly charges a cost that
Exceeds marginal cost
Whenever marginal cost is less than average total cost, average total cost is
Falling
In the long-run equilibrium of a competitive market with free entry and exit
Firms must be operating at their efficient scale and there is no profit
A textbook monopoly results in _____ prices and a ______ quantity of output relative to a competitive industry
Higher, smaller
In what sense do positive externalities cause the so-called "invisible hand" of the marketplace to "fail"?
In the absence of government intervention, markets with positive externalities often fail to produce the maximum total benefit to society, as measured by total surplus.
If marginal revenue is greater than marginal cost, production needs to
Increase
Suppose you read in the Wall Street Journal that the United States is one of the world's largest exporters of rice. Further suppose you read that Congress just passed legislation placing a tax on a key pesticide used in rice production, which effectively increases the price of the pesticide to rice producers. Ceteris paribus, it follows that the equilibrium price of rice will ______, and equilibrium quantity exchanged will ______.
Increase; decrease
Ceteris paribus, in a market with a binding price ceiling, an increase in the ceiling price will ____ the quantity supplied, ____ the quantity demanded, and ____ the _____.
Increase; decrease; decrease; shortage
Ceteris paribus, in a market with a binding price floor, an increase in the floor price will ____ the quantity supplied, ____ the quantity demanded, and ____ the _____.
Increase; decrease; decrease; surplus
Governments often respond to monopoly power with antitrust laws
Sherman Antitrust Act- 1890 Clayton Antitrust Act- 1914
Refer back to the barley question and suppose barley and hops are complements. After the change in the barley market occurs, ceteris paribus, it follows that the equilibrium price of hops will ______, and equilibrium quantity exchanged will ______.
Increase; increase. If X and Y are complements, then an increase in the supply of X (barley), will decrease the price of X and increase the consumption of X. Consequently, this will lead to an increase in the demand for Y (hops), and hence lead to an increase in both the price and quantity exchanged of Y
If rice and potatoes are substitutes, then, ceteris paribus, it follows that the change described in the rice market will have the following impact on the potato market: The equilibrium price of potatoes will _____ and the equilibrium quantity exchanged will ______.
Increase; increase. If X and Y are substitutes, then a decrease in the supply of X (rice), say from an increase in the price of an input, will increase the price of X and decrease the consumption of X. Consequently, this will lead to an increase in the demand for Y, and hence an increase in both the price and quantity exchanged of Y (potatoes), all ceteris paribus, of course.
The government can deal with the problem with monopoly in 4 ways
Increasing competition with antitrust laws Regulation Public ownership Doing nothing
Explicit costs
Input costs that require an outlay of money by the firm
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
Keep producing in the short run but exit the market in the long run
The monopolist produces ______ than the socially efficient quantity of output
Less
Above the socially efficient quantity, increasing output
Lowers total surplus
The shutdown point is the intersection between
MC and AVC
Characteristics of competition
Many buyers and sellers Products tend to homogeneous No major barriers to entering or exiting the market
A competitive firm maximizes profit by choosing 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.
Marginal, average variable
A monopoly's demand curve is the
Market demand curve
When firms price discriminate they are trying to convert consumer surplus and deadweight loss and consumer surplus into
Monopoly profit
Ceteris paribus, if cross price elasticity of demand for two goods, X and Y is _____, then it follows that X and Y are _____. If the income elasticity of demand for Z is _____, then it follows that Z is ______.
Negative, complements; positive, normal.
Does a deadweight loss occur when price discrimination is used?
No
Because public goods are said to be _____, it follows that _____.
Non-excludable; people have an incentive to be free riders.
Suppose you produce X, and your economist tells you the demand for X is: X = 20 - 5P, and the supply of X is: X = 5 + 10P. Ceteris paribus, it follows that the demand for X ______ the law of demand, and the supply of X ______ the "law" of supply.
Obeys; obeys. The demand function is negatively sloped, and the supply function is positively sloped; so, yes, these functions obey the laws of demand and supply, respectively
In the long-run equilibrium of a competitive market with identical firms, what are the relationships among price P, marginal cost MC, and average total cost ATC?
P = MC and P = ATC
Shape of ATC curve
Parabola
A good is said to be "excludable" if:
People can easily be prevented from consuming it.
Typically, in the short run, competitive firms will maximize profits at the level of output that corresponds with
Price = marginal cost
The process of entry and exit ends only when
Price and average total cost are driven to equality
Total revenue is proportional to the amount of output because
Price stays the same
Although economists often argue about how to categorize specific goods in goods in terms of whether or not they are public goods, club goods, and so forth, ceteris paribus, it is safe to categorize goods that are excludable and rival as __________, and goods that are non-excludable and non-rival as ____________.
Private goods; public goods
Dividend
Profit earned by a corporation and distributed to its shareholders
Return on equity is
Profit/Capital
The total-cost curve is the relationship between
Quantity produced and total cost
Suppose the market for wheat is characterized by a downward sloping demand curve and an upward sloping supply curve. Now suppose a price floor is established for wheat, and the floor price is above the equilibrium price. Ceteris paribus, at the newly established floor price the:
Quantity supplied of wheat will exceed the quantity demanded, creating a surplus. A price floor is the legally determined minimum price that sellers may charge. If the government imposes a price floor above equilibrium, then the quantity demanded will be less than the quantity supplied, and there will be a surplus in the market, ceteris paribus.
Below the socially efficient quantity, increasing output
Raises total surplus
When the quantity produced is large, the total-cost curve is
Relatively steep
Suppose that there is technological improvement in the harvesting equipment used in the Florida and California orange industry. If apples and oranges are substitutes, then, ceteris paribus, it follows that
The equilibrium price of apples will increase. The technological improvement increases the supply of oranges, reducing their price and increasing the quantity exchanged. As result, the demand for substitute goods (such as apples) decreases, which leads to a decrease in their price and in the quantity exchanged.
Refer to the problem where the "free-market" demand for X is given by: P = 60 - 2X; and the "free-market" supply of X is given by P = 20 + 2X. Suppose the government imposes a price floor of P = 5. It follows that the ceiling will generate:
The equilibrium quantity of X, i.e. the floor is not binding.
Marginal firm
The firm that would exit the market if the price was any lower
Government regulation
The government gives a single firm the exclusive right to produce some good or service
What gives the government the power to regulate mergers between firms? Give a good reason and a bad reason (from the perspective of society's welfare) that two firms might want to merge.
The government has the power to regulate mergers between firms because of antitrust laws. Firms might want to merge to increase operating efficiency and reduce costs, something that is good for society, or to gain market power, which is bad for society.
Marginal product
The increase in output that arises from an additional unit of input
The monopolist's profit-maximizing quantity of output is determined by
The intersection of the marginal-revenue curve and the marginal-cost curve
What are the main characteristics of a competitive market?
The main characteristics of a competitive firm are: (1) there are many buyers and many sellers in the market; (2) the goods offered by the various sellers are largely the same; and (3) usually firms can freely enter or exit the market.
Total cost
The market value of the inputs a firm uses in production
Short run
The period of time during which at least one of a firm's inputs is fixed
Long run
The period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant
The firm's long-run supply curve is
The portion of its marginal-cost curve that lies above average total cost
Monopoly power is
The power to influence market price
Economics of scale
The property whereby long-run average total cost falls as the quantity of output increases
Constant returns to scale
The property whereby long-run total average cost stays the same regardless of output
Diminishing marginal product
The property whereby the marginal product of an input declines as the quantity of the input increases
Efficient scale
The quantity of output that minimizes average total cost
Industrial organization
The study of how firms' decisions about prices and quantities depend on the market conditions they face
Suppose that, recently, during tropical storm Harvey, off-shore oil-extraction and refining equipment was damaged or temporarily shut down. Ceteris paribus, which of the following scenarios best describes what one would expect to happen in the market for crude petroleum as a result of the storm?
The supply of crude petroleum decreased; the equilibrium price increased; and the equilibrium quantity exchanged decreased. The storm damage works just like a negative technological change (similarly, it temporarily reduces the number of firms in the market), which leads to a decrease in supply, a decrease in the quantity exchanged in the market, and an increase the market price, ceteris paribus.
Deadweight loss is
The total surplus lost because of monopoly pricing
The long-run equilibrium condition in a competitive industry is
The zero profit condition
Suppose a rent control law (i.e. a price ceiling) is passed in the city of Charlotte. If the free-market equilibrium rent for a one-bedroom apartment is $700 per month, then, ceteris paribus, it follows that:
There will be a shortage of one-bedroom apartments if the rent ceiling is $650 per month. Rent control is an example of a price ceiling, which is the legally determined maximum price that sellers may charge. If the government imposes a price ceiling below equilibrium, then the quantity demanded will be greater than quantity supplied, and there will be a shortage in the market, ceteris paribus.
Companies are often better off operating on a loss than shutting down because
They would still have to pay fixed costs whether or not they are operating
Suppose the price elasticity of demand for automobiles is -2. If the price of automobiles increases, as a result of an increase in the price of an input used in automobile production, ceteris paribus, it follows that:
Total annual expenditures on automobiles will decrease. By definition, a good with an elastic demand will see, in absolute value terms, an increase in price that is mathematically overwhelmed by a decrease in quantity demanded: |%ΔQ|>|%ΔP|; thus total amount consumers spend on the good (i.e. the total revenue received by firms selling the good) will decrease in this case
Define total cost, average total cost, and marginal cost. How are they related?
Total cost consists of the costs of all inputs needed to produce a given quantity of output. It includes fixed costs and variable costs. Average total cost is the cost of a typical unit of output and is equal to total cost divided by the quantity produced. Marginal cost is the cost of producing an additional unit of output and is equal to the change in total cost divided by the change in quantity. An additional relation between average total cost and marginal cost is that whenever marginal cost is less than average total cost, average total cost is declining; whenever marginal cost is greater than average total cost, average total cost is rising`
Average total cost
Total cost divided by the quantity of output
Accounting profit
Total revenue minus explicit cost
Profit is
Total revenue minus total cost
Economic profit
Total revenue minus total cost, including both explicit and implicit costs
When are companies better off operating on a loss?
When price is between the ATC and AVC
In the long run, firms that do not at least cover their opportunity cost
Will be driven out of business
Suppose the initial equilibrium for chocolate milk is $2.00 per quart and 200 quarts are sold per week; now suppose as a result of a decrease in supply, the new equilibrium is $4.00 per quart and 100 quarts are sold per week. Using the midpoint formula for the price elasticity of demand, which of the following would yield the elasticity for chocolate milk?
[(200-100)/((200+100)/2)]/[(2.00-4.00)/((2.00+4.00)/2)]