Micro Test 3 (Chapter 6, 7, 8, 10)

Suppose that a monopolist can sell 5 units of output at a price of $5 or 6 units of output at a price of $4. What is the marginal revenue of the sixth unit?

-1

2. Public goods are nonexcludable and nonrival.

-Because they are nonexcludable, it is difficult to get people to pay for them voluntarily. -Because they are nonrival, production costs do not significantly change with additional users.

4. Common resources are goods that are nonexcludable but rival.

-Consumers cannot be excluded from consuming these goods, but when anyone consumes it, there is one less for everyone else. -There is a strong incentive to consume these resources before others.

Compare to a market equilibrium with no externalities:

-External cost in production -External benefit in consumption

1. Private goods are excludable and rival.

-Most goods are private goods. -Private goods can be efficiently provided in competitive markets.

Recall the profit-maximizing rule for firms with monopoly power:

-Produce the Q at which MR = MC. -Based on that Q, charge as much as the market will bear (found by the position of the demand curve).

Examples of external costs:

-air and water pollution -texting while driving -chemical runoff that affects fish stocks

A cost or benefit that is not accounted for in the market price

-an external cost ("negative externality") -an external benefit ("positive externality")

Examples of Network Externalizes:

-communication systems, e.g., telephones, telegraphs, fax machines. -railway systems. -hub-and-spoke air travel

Barriers to entry are essential for monopolies. They generate profit for the monopolist in the short run and long run. This can take the form of:

-control of natural resources or inputs. -increasing returns to scale. -technological superiority. -network externality. -government-made barriers, including patents and copyrights.

The long-run market equilibrium in a perfectly competitive industry with identical firms results in all firms:

-earning zero economic profit. -producing the quantity associated with their break-even price. -producing the profit-maximizing quantity at which MR = MC.

Examples of external benefits:

-education -beehives next to almond orchards -preserved farmland

In order to develop models and make predictions about how producers will behave, we have developed four principal models of market structure:

-perfect competition -monopoly -oligopoly -monopolistic competition

Common techniques for price discrimination:

1. advance purchase restrictions 2. volume discounts 3. two-part tariffs

1 in 4 accidents (250,000 per year) are caused by cell phone use

43 states have banned it... because of the negative (fatal) externalities.

3. Technological Superiority

A firm that maintains a consistent technological advantage over potential competitors can establish itself as a monopolist.

2. Increasing returns to scale

A natural monopoly exists when increasing returns to scale (economies of scale) provide a large cost advantage to a single firm.

Price regulation:

A price ceiling imposed on a monopolist does not create shortages if it is not set too low

The marginal social cost of pollution is the additional cost imposed on society as a whole by an additional unit of pollution

Acid rain, smog, contaminated water, etc.

How a Monopolist Maximizes Profit

All firms face the same rule: Profit is maximized at the Q where MR = MC

Short-run versus long-run costs

All inputs are variable in the long run. This means that in the long run, fixed cost may also vary. The firm will choose its fixed cost (that is, the inputs that are fixed in the short run) in the long run based on the level of output it expects to produce

MR is below the demand curve...

An increase in production by a monopolist has two opposing effects on revenue

If producing another unit adds more to revenue than cost, profit will increase....

Because if MR > MC, producing more will add to profit. And if MR < MC, producing less will add to profit.

Why is the marginal cost curve upward sloping?

Because there are diminishing returns to inputs in this example. As output increases, the marginal product of the variable input declines. This implies that more and more of the variable input must be used to produce each additional unit of output as the amount of output already produced rises. And since each unit of the variable input must be paid for, the cost per additional unit of output also rises.

Public (government) ownership:

But publicly owned companies are often poorly run.

If a good is nonexcludable and nonrival, there is no way for a private firm to earn enough revenue to create as much as society wants,

By taxing everyone and producing the public good, government can make people better off

Profit maximization consists of two steps: 2. Choosing a price

Choose the highest price you can get away with, which is the highest price consumers will pay for that quantity. -Rule: Once you've picked your quantity, follow the graph to the demand curve, which shows you how much consumers will pay.

Standardized product (aka "commodity")

Consumers regard different sellers' products as equivalent`

Why is profit maximized where MR = MC?

Each time the firm produces another unit, there are extra costs and extra revenues.

Emissions tax?

Emissions tax ensures that the marginal benefit of pollution is equal for all sources of pollution (unlike environmental standards).

For most pollutants, the socially efficient level of pollution is zero.

False

Which of the following markets is likely to be the most competitive?

Farm commodities

Perfect competition: Necessary Conditions: Step 2

Free entry and exit

Characterize each of the following items as excludable or nonexcludable. I. IUPUI campus (outdoors) II. Cable television

I is nonexcludable; II is excludable.

1. Control of a scarce resource or input

If De Beers owned nearly all of the diamond mines in the world, it would have a monopoly in diamond production

external cost ("negative externality")

If fracking pollutes drinking water sources

Environmental standards?

Inflexible and don't allow reductions in pollution to be achieved at minimum cost

The rise of the Internet and file sharing has turned media such as movies and music into public goods. How?

It has made those goods nonexcludable.

single-price monopolist:

It offers its product to all consumers at the same price

So how do you measure the marginal social benefit of pollution?

It's the highest willingness to pay for the right to emit that unit measured across all polluters.

So how do you measure the marginal social cost of pollution?

It's the sum of the willingness to pay among all members of society to avoid that unit of pollution. It may be hard to estimate, so society often underestimates it.

The free-rider problem

Many individuals are unwilling to pay for their own consumption and instead will take a free ride on anyone who does pay.

3. Artificially scarce goods are excludable but nonrival.

Markets can provide these goods but do so at an inefficient level. Example: Wi-fi: excludable and essentially nonrival

4. Network Externality

Network externality: the value of a good or service to an individual increasing as more others use the same good or service

Free entry and exit

New producers can easily enter into an industry and existing producers can easily leave that industry

A quantity effect

One more unit is sold, increasing total revenue by the price at which the unit is sold

What are the marginal social benefits associated with generating that pollution?

Output production, jobs, etc.

A firm will NOT produce if

P < min AVC

Since MR = P for competitive firms, the profit-maximizing rule is: Choose the quantity of output where

P = MC

Who probably has more elastic demand for a Hertz rental car? Person A reserves a car online weeks before a trip; person B walks up to a Hertz counter after he walks off an airplane after a four-hour flight? Who probably gets charged more?

Person A has a more elastic demand and will be charged less.

Total Revenue equation

Price x Quantity

Optimal output rule

Profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced is equal to its marginal cost

Profit maximization consists of two steps: 1. Choosing a quantity

Rule: Choose Q where MR = MC.

If the market for some good were converted from a competitive industry to a monopoly, which of the following would occur as a result?

Some consumer surplus would be reallocated to the monopolist as profit

There is zero consumer surplus:

The entire surplus is captured by the monopolist in the form of profit

Antitrust policy

The government policies used to prevent or eliminate monopolies

The spreading effect

The larger the output, the more output over which fixed cost is spread, leading to lower average fixed cost

The diminishing returns effect

The larger the output, the more variable input required to produce additional units, which leads to higher average variable cost

Rival

The same unit of the good cannot be consumed by more than one person at a time (or at all). Example: cheeseburger

Perfect competition: Necessary Conditions: Step 1

There are many buyers and sellers, each with a small market share

price discrimination:

They charge different prices to different consumers for the same good

A price effect

To sell the last unit, the monopolist must cut the market price on all units sold. This decreases total revenue

Monopoly profit comes at consumers' expense:

When a monopoly raises prices and lowers Q, consumer surplus falls and deadweight loss is created.

Suppose a government decides to issue a limited number of tradable pollution permits. Which of the following statements is true?

When the government issues these tradable pollution permits, it effectively creates a market for the right to pollute.

Is it right for consumers to face different prices based on their age?

Yes

Should a competitive firm keep producing even if it faces short-run losses (and is producing at a point on its MC curve that is above the minimum AVC curve)?

Yes, because it covers its variable costs and some fixed costs

External benefit:

a benefit received by people other than the consumers or producers trading in the market

Monopolist

a firm that is the only producer of a good with no close substitutes

When perfect price discrimination can be employed,

a firm will charge each customer a different price : the maximum price each is willing to pay.

In the short run,

a firm will produce if P > shutdown price (min AVC).

The marginal social benefit

a good or activity is equal to the marginal benefit that accrues to consumers plus its marginal external benefit

Marginal Benefit

a good or service is the additional benefit derived from producing one more unit of that good or service

A Pigouvian subsidy:

a payment designed to encourage activities that yield external benefits.

Break-even price

a price-taking firm is the market price at which it earns zero profit

Transaction costs:

all of the costs to individuals of making a deal

There is no deadweight loss,

because all mutually beneficial transactions are exploited

Natural monopolies are a different story: They bring lower costs...

but there's no guarantee the firm will voluntarily pass along its cost savings to consumers.

Marginal cost equation

change in total cost / change in quantity

Marginal revenue equation

change in total revenue / change in quantity

2. An emissions tax:

cost depends on the amount of pollution a firm produces.

In a perfectly competitive industry with free entry and exit,

each firm will have zero economic profit in long-run equilibrium

The socially optimal quantity can be achieved by a Pigouvian subsidy

equal to the marginal social benefit at the optimal quantity.

According to the Coase theorem,

even in the presence of externalities an economy can always reach an efficient solution provided that the transaction costs are sufficiently low

The extra safety your neighbor might have because everyone else in the area has purchased burglar alarms is a(n):

external benefit

If TR = TC,

firm breaks even

If P > break-even (min ATC),

firms are profitable.

total cost equation

fixed cost + variable cost

Average fixed cost equation

fixed cost/quantity

Market failure

free-market equilibrium not providing the socially optimal amount of a good

A patent

gives an inventor a temporary monopoly in the use or sale of an invention

A copyright

gives the creator of a literary or artistic work sole rights to profit from that work

To avoid deadweight loss,

government policy attempts to prevent monopoly behavior.

short-run industry supply curve

how the Q supplied by an industry depends on the market price (given a fixed number of producers).

The LRS shows

how the quantity supplied responds to the price (once producers have had time to enter or exit the industry)

Toilet paper is a rival good because:

if one person uses several sheets of toilet paper, no one else can.

Firms will choose to produce (even at a loss)....

if they can cover their variable AND SOME of their fixed costs

variable cost

is a cost that depends on the quantity of output produced. It is the cost of the variable input.

fixed cost

is a cost that does not depend on the quantity of output produced. It is the cost of the fixed input

perfectly competitive market

is a market in which all market participants are price takers

A technology spillover

is an external benefit that results when knowledge spreads among individuals and firms

perfectly competitive industry

is an industry in which producers are price takers

Fixed input

is an input whose quantity is fixed for a period and cannot be varied

variable input

is an input whose quantity the firm can vary at any time

Asteroid deflection

is both nonexcludable and nonrival

The long-run market equilibrium of a perfectly competitive industry is

is efficient: no mutually beneficial transactions go unexploited.

Marginal product

is the change in output resulting from a one-unit increase in the amount of labor input (ΔQ/ΔL)

long run

is the period in which all inputs can be varied

short run

is the period in which at least one input is fixed

Production

is the process of turning inputs into outputs

The socially optimal quantity of flu shots

is the quantity society would choose if all costs and benefits were fully accounted for

The socially optimal quantity of pollution

is the quantity society would choose if all costs and benefits were fully accounted for

Production function

is the relationship between the quantity of inputs a firm uses and the quantity of output it produces

3. Tradable emissions permits:

licenses to emit limited quantities of pollutants; the licenses can be bought and sold by polluters

The relationship between inputs and output is positive but not constant:

marginal product of labor changes along the production function

The market outcome (no preserved farmland) is inefficient:

marginal social benefit of farmland preservation exceeds marginal social cost

Shut-down price

minimum average variable cost

Nonrival

more than one person can consume the same unit of the good at the same time Example: digital music

total cost

of producing a given quantity of output is the sum of the fixed cost and the variable cost of producing that quantity of output.

produce too few flu vaccinations because

people deciding whether or not to buy a vaccine have no incentive to take into account the benefits it gives to others.

Excludable

people who don't pay can be easily prevented from using a good Example: Jeans

Nonexcludable:

people who don't pay cannot be easily prevented from using the good Example: national defense

Left to itself, a market economy will typically generate too much pollution because

polluters have no incentive to take into account the costs they impose on others

produce too much pollution because

polluters have no incentive to take into account the costs they impose on others.

If a firm is earning positive economic profit, it must be the case that:

price is greater than average cost

1. Environmental standards:

rules that protect the environment by specifying actions by producers and consumers

total product curve

shows how the quantity of output depends on the quantity of the variable input for a given quantity of the fixed input

The long-run average total cost curve

shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output.

industry supply curve

shows the relationship between the price of a good and the total output of the industry as a whole

The total cost curve becomes

steeper as more output is produced, a result of diminishing returns.

Coase's analysis argues that individuals have an incentive to find a way to make mutually beneficial deals that lead them to "internalize the externality":

take externalities into account when making decisions.

Pigouvian taxes:

taxes designed to reduce external costs. Example: an emissions tax designed to reduce coal production

Market power

the ability of a firm to raise prices

Under perfect price discrimination:

the firm captures all consumer surplus as profit

If TR < TC,

the firm incurs a loss

If TR > TC,

the firm is profitable

Market share

the fraction of the total industry output accounted for by that producer's output

Externalities (spillovers):

the impact on third parties of a transaction between others

principle of marginal analysis

the optimal amount of an activity is the quantity at which marginal benefit equals marginal cost

A market is in long-run equilibrium when

the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur

If one worker makes 14 baskets, two workers make 34 baskets, three workers make 45 baskets, and four workers make 50 baskets, which worker yielded the highest marginal product?

the second worker

In a perfectly competitive industry in equilibrium,

the value of marginal cost is the same for all firms

A good is subject to a network externality when

the value of the good to an individual is greater when a large number of other people also use the good

Price-takers

their actions have no effect on price

In a market economy without government intervention,

those who benefit from pollution—like the owners of power companies—decide how much pollution occurs

When the consumption of a good generates positive external benefits, the market tends to produce:

too little of the good, since the market does not take into account the positive external benefits from the consumption of the good.

Average total cost equation

total cost/quantity

Marginal product is the slope of the:

total product curve

Profit equation

total revenue - total cost

In reality, the Coase theorem is unlikely to work because:

transaction costs are often high, making negotiations difficult

Average variable cost equation

variable cost/quantity

At high levels of output the spreading effect is:

weaker than the diminishing returns effect

There are increasing returns to scale (economies of scale)

when long-run average total cost declines as output increases

There are decreasing returns to scale (diseconomies of scale)

when long-run average total cost increases as output increases

There are constant returns to scale

when long-run average total cost is constant as output increases

A good is subject to a network externality

when the value of the good to an individual is greater when a large number of other people also use that good

If Gnomes-R-Us (a competitive firm) produces where the marginal cost curve intersects with the average total cost curve at its minimum point, the firm will earn

zero economic profits