ECON 2301 Exam 3

Optimal method of production is the one that

minimizes cost

The price of Leisure

"buying" more leisure means to reallocate time between work and nonwork activities For each hour of leisure you consume you give up one's hour's wage wage rate- price of leisure

Total Costs

made up of total fixed cost and total variable costs

2 decisions that households make an input markets

-labor supply decision -savings decision

To calculate costs a firm must know 2 things

-what quantity and the combination of inputs it needs to produce its product -how much those inputs cost

More normal goods and leisure are consumed when the price of a normal good​ falls, or when wages​ rise, because of the income effect. What happens with the substitution​ effect? A) More normal goods are purchased while less leisure is​ consumed, because the higher wage rate costs more in forgone wages. B) More normal goods are purchased and more leisure is​ consumed, because the higher wage rate costs less in forgone wages. C) Fewer normal goods are purchased and less leisure is​ consumed, because the higher wage rate costs more in forgone wages. D) Fewer normal goods are purchased while more leisure is​ consumed, because the higher wage rate costs more in forgone wages.

A

Marginal Product

the additional output that can be produces by adding one more unit of a specific input , ceteris paribus (holding all else equal)

Average Product

the average amount produced by each unit of a variable factor of production.

Financial Capital Market

the complex set of institutions in which suppliers of capital (households that save) and the demand for capital (firms wanting to invest) interact.

Last year you earned a revenue of $90000. Costs for equipment,rent and supplies were $60,000. To start this business you invested an amount of your own capital that could pay you a return of $40,000. During the year what was your economic costs?

$100,000

Perfect Competition

industry structure in which there are many firms, each small relative to the industry, producing identical products and in which no firms is large enough to have any control over prices ; new competitors can freely enter the market and old firms can exit.

Spreading Overhead

process of dividing total fixed costs by more units of output. Average fixed costs decline as quantity rises

Production

process which inputs are combined, transformed, and turned into outputs

Total Revenue minus total cost is equal to...

profit

Economic Profit

profit that accounts for both explicit costs and opportunity costs Economic Profit= TR- total economic costs (all costs of production+opportunity costs+ wages paid+ interest paid on loans)

If a units marginal revenue exceeds its marginal costs, profits will (rise/fall) if you decide to produce that unit

profits will rise

Production function or total product function

relationship between inputs and putputs (produce technology) expressed numerically or mathematically

Labor Supply Curve

shows quantity of labor supplied at different wage rates shape depends on how the household reacts to a change in wage rate

law of Diminishing returns

states that after a certain point, when additional units of a variable input are added to fixed inputs, the marginal product of the variable.

Accounting profit is calculated by

taking total revenue and subtracting explicit costs. It does not take opportunity costs into account. The accounting profit is calculated as total revenue minus explicit​ (accounting) costs, which are the​ wages, interest​ paid, and other expenses.​

Capital-Intensive Technology

technology that relies heavily on capital instead of human labor

Labor Intensive Technology

technology that relies heavily on human labor instead of capital

The assumption of a fixed factor of production in the short run means what?

that a firm is stuck at its current max scale of operation

Long Run

that period of time for which there are no fixed factors pf production. Firms can increase/decrease the scale of operation, and new firms can enter or exit an industry

Marginal cost

the increase in total cost that reuslts from producing 1 more unit of output. Reflects changes in variables costs because they vary when output changes measures the additional cost of inputs required to produce each successive unit of output.

Profit

difference between total revenue (TR) and total cost (TC)

Average Variable Cost (AVC)

total variable cost divided by the # of units of output; a per unit measure of variable costs

True/False: The wage rate can be thought of as the opportunity cost of the benefits of leisure.

true

True/False: capital and labor are complimentary inputs

true

Homogenous Poducts

undifferentiated products; products that are identical to, or indistinguishable from, one another

Saving

using present income to finance future spending.

Profit is equal to

Total Revenue minus total cost

Variable Costs

a cost that depends on the level of production chosen

Total Revenue (TR)

amount recieved from dale of the product (P x Q)

True/False: The wage rate is the price of leisure.

false

income effect of a wage increase implies buying (more or less) leisure and working (more or less).

more; less

You own a building that has four possible uses with a value for that use: - cafe $2000 - craft store $3000 - hardware store $4000 - bookstore $5000. If you decide to open up a hardware store, what would be the opportunity costs for that use.

$5000

Goals of a firms

- demand inputs - engage in production - produce outputs -incentive to max profits and minimize production costs

The Wax Works sells 500 candles at a price of $5 per candle. The Wax Works' total economic costs for producing 500 candles are $3000. The Wax Works' economic profit is....

-$500

In the short run, these two conditions hold

-existing firms face limits imposed by some fixed factor of production -new firms cannot enter and existing forms cannot exit an industry

All firms make these basic decisions to achieve max profits:

-how much output to supply (quantity of product) -how to produce that output (which produce technique and technology to use) -how much of each input to demand

Firm

exists when a person or a group o people decides to produce a good or service to meet a perceived demand Engages in production because they can sell their products for more than it costs to produce them.

f leisure is a normal​ good, the income effect of a wage increase suggests that the labor supply curve will ​ ________, and the substitution effect of a wage increase suggests the labor supply curve will​ ________. A.slope​ downward; slope upward Your answer is correct. B.slope​ upward; slope upward C.slope​ upward; slope downward D.slope​ downward; slope downward

A

A firm earning zero economic profits is probably suffering losses from the standpoint of general accounting principles. Do you agree or disagree with this​ argument? It is actually earning a​ ________ given the extent of the risks involved. The full economic​ cost, including opportunity​ costs, is included in ​ _______ cost but not in​ _______ cost. A.normal rate of return​ (or profit);​ accounting; economic B.normal rate of return​ (or profit);​ economic; accounting C.negative accounting​ profit; accounting; economic D.negative accounting​ profit; economic; accounting

B

During​ 2010, Congress debated the advisability of retaining some or all of the tax cuts signed into law by former President George W. Bush in 2001 and 2003 and set to expire at the end of 2010. By reducing tax rates across the​ board, take-home pay for all taxpaying workers would increase. The​ purpose, in​ part, was to encourage work and increase the supply of labor. Households would respond the way the president​ hoped, but only if income effects were stronger than substitution effects. Do you agree or​ disagree? A) Disagree: The income effect cannot be stronger than the substitution effect. B) ​Disagree: If the income effect were stronger than the substitution​ effect, households would work less. C) Agree: Households responded the way the president hoped. D) Agree: If the income effect were stronger than the substitution​ effect, households would work more.

B

Substitution effect is greater than the income effect then the wage increase will do what to the labor supply?

Increase - labor supply curve slopes upward and positive slope

For most normal​ goods, the income effect and the substitution effect work in the same​ direction; so when the price of a good​ falls, both the income and substitution effects lead to a higher quantity demanded. How would this change if the good is an inferior​ good? A) The income effect and the substitution effect would continue to work in the same direction. B) If the price of an inferior good​ falls, the income effect would lead to an increase in quantity demanded. C) The income effect and the substitution effect would work in opposite directions. D) If the price of an inferior good​ falls, the substitution effect would lead to a decrease in quantity demanded.

C

Income Effect of a Price change

Change in consumption of original product due to the improvement in well-being/feeling richer.

After working for 25 years as personal fitness trainers while raising their​ kids, three sisters cashed in a total of ​$80,000 in bonds and decided to open a​ small, neighborhood fitness center. They spent the ​$80,000 on exercise​ equipment, advertising, computer​ equipment, and other furnishings for the business. For the next 3​ years, they took in ​$150,000 in revenue each​ year, paid themselves ​$30,000 annually​ each, and rented a space in a strip mall for ​$25,000 per year. Before the​ investment, their ​$80,000 in bonds were earning interest at a rate of 8 percent. Are they now earning economic​ profits? Explain​ your answer. A.They are earning profits of ​$45,000​, which takes into account the ​$80,000 opportunity cost of their capital. B.They are earning profits of ​$125,000 ​, which takes into account the opportunity cost of their capital. C.They are earning profits of ​$28,600​, which takes into account the ​$6,400 opportunity cost of their capital and the ​$90,000 combined opportunity cost of their own labor. D. They are earning profits of ​$118, 600​, which takes into account the ​$6,400 opportunity cost of their capital.

D

The average cost of living is approximately the same in the following four​ cities: Sarasota,​ FL; Cleveland,​ OH; Cheyenne,​ WY; and​ Phoenix, AZ. Use the information you have learned about marginal utility and the substitution effect to explain whether you believe a​ consumer's purchasing choices would remain the same in each of these cities. Assume that her income would be the same in each city. A) The fact that the average level of prices is the same in all four cities carries no implications about the individual prices making up the average in each locale.​ And, as we know from consumer​ theory, it is the individual ratios of marginal utilitiy to price for all items available that guide consumer decision making. B) Unless individual prices are also the​ same, a consumer following the​ utility-maximizing rule will not make the same choices. In each locale items yielding more marginal utility per dollar will be substituted for those yielding less. C) Because the same consumer may actually experience variations in tastes from one locale to​ another, even the existence of identical individual prices will not have her making the same choices when she follows the​ utility-maximizing rule. D) All of the above

D

Labor Supply Decision

Decisions about whether to work, what kind of work they will do, and what jobs to take Constraints: skills they possess, available jobs, and market wage levels, 168 hours in a week. Involves a set of trade offs - how you could of been spending your time differently

Consider a firm that uses capital and labor as inputs and sells 20,000 units of output per year at the going market price of ​$15. Also assume that total labor costs to the firm are ​$248,500 annually. Assume further that the total capital stock of the firm is currently worth ​$400,000​, that the return available to investors with comparable risks is 10 percent​ annually, and that there is no depreciation. Is this a profitable​ firm? Explain your answer. A. The firm is not profitable because profit equals ​$11,500. B. The firm is profitable because profit equals ​$51, 500. C. The firm is not profitable because profit equals ​$negative 348, 500. D.The firm is profitable because profit equals ​$300, 000. E.The firm is profitable because profit equals ​$11, 500.

E

Price of a good or service falls and the household is better off (higher real income). What effect is used (income or substitution) and how does the households respond with their purchasing patterns?

Income Effect Household buys more

Remy is a New Orleans native who has lived for the past 7 years in Boston. For each of the last 7​ years, he has made trips back to New Orleans for Mardi​ Gras, Jazz​ Fest, and Halloween. During​ 2015, the price of a​ round-trip ticket from Boston to New Orleans decreased from​ $575 to​ $350. As a​ result, Remy decided to buy new Mardi Gras and Halloween costumes that year and also decided to purchase tickets to see Harry​ Connick, Jr. perform at the TD Garden Arena in Boston. Explain how​ Remy's demand for Halloween costumes and concert tickets will be affected by a decrease in air travel prices. Explain why both income and substitution effects might be expected to increase Remy's number of trips to NOLA

Remy's demand for the halloween and Mardi Gras costumes and concert tickets will be affected for these items will rise because less of his income will be used for plane tickets Cheaper air travel increases real income and lowers the opportunity cost of trips to NOLA

Graphing total variable costs and marginal costs

Slope of TVC= Change in TVC/change in quantity= Change in TVC= Marginal Cost

A rise in price of Pepsi causes a household to shift its purchasing patterns toward Coke and away from Pepsi is the (?) effect of a price change.

Substitution

Prices of a good or service and the opportunity costs of the good rise. What effect is in effect (income/substitution) and how does the household respond?

Substitution Effect Household buys less

Price of a good or service falls and the opportunity cost of the good falls. What effect is used (income/substitution) and how does the household respond?

Substitution Effect Household buys more

Tyrell is consuming X and Y so that he is spending his entire income and MUx/Px= 7 and MUy/Py=7. To maximize utility, he should consume...

The same amount of X and Y since he is already maximizing utility.

True/False: In a labor market, income and substitution effects work in opposite directions when leisure is a normal good

True

True/False: In a perfect competition each firm takes prices as given (that are determined by supply and demand) and decides how much to produce and how to produce it

True

True/False: Perfectly competitive firms sells each unit of product for same price (market price) regardless of individual output level it has chosen.

True

True/False: The decrease in purchases of a good when its price increases due to the decline in​ well-being is called the income effect of a price change.

True

True/False: The normal rate of return on capital is the opportunity cost of capital.

True

True/False: production is the process through which inputs are combined and transformed into outputs

True

Borrowing

Using future income to finance present present spending.

short run implies what of the marginal cost

eventually rises with output

Substitution effect of a price change

a fall in price of product x might cause a household to shift its purchasing patterns away from substitutes of product x. a rise in price of product x might cause a household to shift its purchasing patterns towards substitutes of product x.

Total Variable Cost Curve

a graph that shows the relationship between total variable cost and the level of a firm's output

Relationship between ATC an MC

exactly the same as between average variable cost and marginal cost average total cost curve follows the marginal cost cure but lags behind because it is an average over all units of output

Normal Rate of Return

a rate of return on capita that is just sufficient to keep owners and investors satisfied.

Difference between marginal revenue and marginal cost is shrinking, still positive and added output means (added/less) profit

added

Marginal Revenue (MR)

added revenue that a firm takes in when it increases output by one additional unit. In perfect competition, the MR= price

income effect of wage effect

an increase in wages makes the consumer feel better off

Fixed Costs

any cost that does not depend on the firms level of output. Costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run

When interest rates​ rise, the substitution effect indicates that people will save​ ________, and the income effect indicates that people will save​ ________. A.less; less B.​less; more C.more; less D.more; more

c

Variable Capital

capital that can be changed in the short run (EX: rented piece of equipment)

If marginal revenue costs exceed marginal revenue, producing that unit will cause profits to (rise/decline)

decline

True/False: The optimal level of production is the production level that maximizes cost for a given level of output.

false

to calculate potential profits

firms must combine their cost analyzes with info. on potential revenues from sales

Profit Maximizing Level of Output

goal: to max difference between TR and total cost, which is equivalent to maximizing profits

Marginal Revenue curve

how much revenue the firm will gain by raising output by 1 unit at every level of output marginal revenue and demand curve facing a competitive firm are identical

Prices of a good or service rises and the household is worse off (lower income). What effect is used (income/substitution) and how does the household respond?

income effect household buys less

Income Effect

increase/decrease in purchases of a good when its prices change that come from a change in how rich/poor you feel as a result of that price change.

As Uber continues to become a more​ convenient, and in many​ cases, less costly alternative to traditional taxi service for many of its​ customers, the income and substitution effects have an impact on the demand side of the market. Using Uber compared to traditional taxi service makes the household better​ off, and real income has (increased/decreased) . The income effect therefore allows (more/less) Uber service to be consumed.

increased; more

If income effect outweighs substitution effect, a higher wage will lead to (more or less) consumption of leisure and the labor supply will (increase or decrease)

more; decrease (implies the labor supply curve "bends back"

If the price of a normal good​ falls, the substitution effect suggests that we will purchase​ ________ of that​ good, and the income effect suggests that we will purchase​ ________ of that good.

more; more

Short Run

the period of time for which two conditions hold: the firm is operating under a fixed scale (fixed factor) of production and firms can neither enter nor exit an industry

Optimal method of production

the production method that minimizes cost for a given level of output

Production Technology

the quantitive relationship between inputs and outputs

Firms cannot enter an industry in which positive profits are being earned in...

the short run

Total Fixed costs

the total of all costs that do not change with output even if output is zero called overhead Represent a larger portion of total costs for some firms than for others

In the long run

there are no fixed factors of production

Total Revenue (TR)

total amount that a firm takes in from the scale of its product: the price per unit times the quantity of output the firm decides to produce (P xQ)

Average Total Cost (ATC)

total cost divided by the # of units of output; a per-unit measure of total costs

Average Fixed Costs

total fixed cost divided by the # of units of output; a per-unit measure of fixed costs

Total Variable Cost (TVC)

total of all costs that vary with output in the short run to produce more outputs, a firm uses more inputs depends on - techniques of production that are available - prices of the inputs required by each technology

Total Cost (TC)

total of out of pocket costs and opportuity costs of all factors of production - out of pocket costs= explicit costs/accounting costs - Economic costs= include opportunity cost of every input (referred to as implicit costs)

Economic Profit can be calculated as

total revenue -(explicit costs+ implicit costs)

Total amount of satisfaction yielded by the consumption of a good or service is called

total utility