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ECO 211 Final

5/9/2011 1:43:00 PM

Chapter 13- Production Costs Total revenue: the amount that the firm receives for the sale of its output. Total cost: the amount that the firm pays to buy inputs. (implicit + explicit cost) Profit: a firms total revenue minus its total cost. Explicit costs: costs that require an outlay of money by a firm. Implicit cost: cost that do not require an outlay of money by a firm (opportunity cost). Accounting cost: includes explicit costs only. Economic cost: includes implicit and explicit costs. Accounting profit: total revenue minus accounting cost. Economic profit: total revenue minus economic cost. Economic profit <= accounting profit. Product function: the relationship between the quantity of inputs and the quantity of outputs. The production function gets flatter as the number of inputs increases, which reflects diminishing marginal product (concave down). Marginal product: the increase in quantity of output obtained from one additional unit of that input. Marginal productivity of labor: tells us how much more output we get for an additional unit of labor. MPL= output/ L Diminishing marginal product: the property whereby the marginal product of an input declines as the quantity of the input increases. Total-cost curve: shows the relationship between the quantity of output produced and total cost of production. The total-cost curve gets steeper as the quantity of output increases because of diminishing marginal product (concave up). Fixed costs: costs that do not vary with the quantity of output produced. Variable costs: cost that do vary with the quantity of output produced. Average total cost: total cost divided by the quantity of output. Average fixed cost: fixed costs divided by the quantity of output. Average variable cost: variable costs divided by the quantity of output. Marginal cost: the increase in total cost that arises from an extra unit of production. Average total cost= average variable cost + average fixed cost.

If MC > ATC, ATC is rising. If MC < ATC, ATC is falling. MC intersects ATC at its minimum. Efficient scale: the quantity of output that minimizes average total cost. In the long run, fixed costs become variable. Long run average total cost will be a flat U-shaped curve. Economies of scale is on the left, constant returns of scale is in the middle, and diseconomies of scale is on the right. Economies of scale: when long run average total cost declines as output rises.

Diseconomies of scale: when long run average total cost rises as output rises. Constant returns of scale: when long run average total cost stays the same as the quantity of output changes. Chapter 14- Firms in Competitive Markets Competitive market: a market with many buyers and many sellers trading identical products so that each buyer and seller is a price taker. Firms can freely enter and exit the market. Average revenue is the total revenue divided by the quantity sold. For all firms, average revenue equals the price of the good. Marginal revenue: the change in total revenue from an additional unit sold. For competitive firms, marginal revenue equals the price of the good. Competitive firms are price takers: MR = AR = P Competitive firms are profit maximizers. Profit is maximized when MR=MC. The firm is going to choose a q such that MR = MC. Because the firms marginal-cost curve determines the quantity of the good the firm is willing to supply at any price, it is the competitive firms supply curve. Sunk cost: a cost that has already been committed and cannot be recovered. Short run decisions to shut down: a firm will shut down if TR < VC or if P < AVC. Long run decision to exit or enter a market: a firm will exit the market if TR < TC or if P < ATC. A firm will enter the market if P > ATC.

Long run equilibrium: Competitive firms earn zero profit, price = AC. Price < MC, firms operate at the efficient scale (q such that price= lowest ATC). Long run analysis: if p< ATC profit is less than zero. Firms will exit the market and market supply will decrease. Market supply curve will shift the left causing price to increase. Firm will continue to exit the market until profit is zero or price = ATC. In the LR< individual output has increased and market output has decreased. Long run analysis: If p> ATC profit is greater than zero. Firms will enter the market and market supply will increase. Market supply curve will shift to the right. Price will decrease until profit is zero or price = ATC. In the

LR, individual output will decrease and market output will increase. At the profit maximizing level of output MR = MC. If MR > MC a firm should increase production to increase profit. IF MR< MC a firm should decrease production to increase profit. Chapter 15- Monopoly Monopoly: a firm that is the sole seller of a product without close substitutes. The fundamental cause of a monopoly is barriers to entry. Barriers to entry have three main sources: A key resource is owned by a single firm. The government gives a single firm the exclusive right to produce some good or service. The costs of production make a single producer more efficient than a large number of producers. Monopoly is a price maker. Sets price by controlling the output. Resource monopoly: monopoly that has sole ownership over key resource that is used in the production of a good. Government created monopoly: the government may grant a firm sole rights to produce and sell a good. Patents- issued by government to allow a single entity to sell or produce a good for 20 years. Natural monopoly: Exist because it is more costly to society to have more than one firm (ex: FPL, utilities). The monopolist is a profit maximizer (MR= MC). Price > MR. MR = MC. In monopolized markets price exceeds marginal cost. At the monopolist price, there are buyer who are willing to buy but not able to. Monopoly is a profit maximizer not a social maximizer. It is going to produce at a less than efficient level. The end result is deadweight loss.

Anti-trust laws: Government prohibits the merger of rims in an effort to foster competition. Sometimes mergers lead to lower average costs (synergies). Government can regulate the monopolys pricing behavior. If AC is greater than the regulated price, profit is less than zero. This drives the monopoly out of business. The next best thing is to set price = AC. This makes profit zero and DWL small. Chapter 16- Oligopoly Oligopoly: A market with few sellers selling a similar or identical product. Game theory: the study of how people make strategic decisions. Markets with few sellers- There is a tension between cooperation and self-interest. Cartel: when two or more firms collude. These firms operate as a monopoly. The cartel price is the monopoly price. The cartel output is the monopoly output. Since there are multiple firms they must agree on their share of output. Cartels are difficult to maintain given that contracts cannot be enforced. Collusion: when two or more firms agree on total output and price. Nash equilibrium: a situation where economic actors choose their best

strategy given all the strategies of competing players. Prisoners Dilemma: A particular game between two captured criminals showing the difficulties in maintaining cooperation. If Jack and Jill cooperate they would earn higher profits, but due to selfinterests they will charge a price lower than the monopoly price and produce at an output higher than the monopoly output. Chapter 17- Monopolistic Competition Monopolistic competition: a market structure in which many firms sell products that are similar but not identical. Many sellers, product differentiation, free entry and exit. Monopolistic competitors maximize profit by producing the quantity at which marginal revenue equals marginal cost. If the monopolistic price > AC, profit > 0. If monopolistic price < AC, profit < 0. D* = individual firms demand function. It represents the proportion of market demand. If firms enter the market D* decreases. If firms exit the market D* increases.

Long run equilibrium: if the monopolistic price > AC, profit > 0. Firms will enter the market. D* decreases, price decreases until profit = 0. Long run equilibrium: if the monopolistic price < AC, profit < 0. Firms will exit the market. D* increases, price increases until profit = 0. In the long run monopolistic competitors earn zero profit. There is still a DWL. Product markup: price > MC. Excess capacity: The monopolistic competitor produces at a cost higher than the minimum AC. Due to product markup and excess capacity there is a DWL in the LR.

Efficient level of output is when price = MC. Chapter 21- Theory of Consumer Choice Budget constraint: the limit on the consumption bundles that a consumer can afford. Slope = -Px/Py. Y-int= I/Py. X-int= I/Px. We assume consumers are utility maximizers. Indifference curves: shows all the combinations of goods that gives the consumer equal satisfaction. Marginal rate of substitution: the rate at which a consumer is willing to trade one good for another. This is the slope of the indifference curve at any point. Higher indifference curves are preferred to lower ones. Indifference curves are downward sloping. Indifference curves do not cross. Indifference curves are bowed inward. If two goods are perfect substitutes the indifference curve is linear. If two goods are perfect complements the indifference is L-shaped. The consumer is a utility maximizer: chooses a bundle that maximizes satisfaction. The consumer wants to attain the highest indifference curve possible, but is limited by the budget. The consumer will exhaust the entire budget. The optimal choice is where the budget line and indifference curve are tangent to each other. At the optimal point, slope of B.C. = slope of I.C. Slope of I.C. = -Mux/Muy. Mux= dU/dx: how much more happiness a consumer attains for an additional unit of good x. On the indifference curve, the utilities are equal for all combinations of x and y.

The marginal utility of a dollar spent on good x is equal to the marginal utility of a dollar spent on good y. If Mux/Px > Muy/Py the consumer would consume more x and less y until Mux/Px= Muy/Py. If income rises, the budget line shifts. If the B.C. shifts, the bundle will change. If the price of good x rises, I/Px shifts left. As the price rises, the amount consumed falls (law of demand).

5/9/2011 1:43:00 PM

5/9/2011 1:43:00 PM