Basic Economics

1) Economics the social science that focuses on the usage of resources

2) Microeconomics branch of economics that studies use of resources by individuals,
households, firms and industries
3) Macroeconomics study of the national economy
4) Production Possibility Curve (PPC) opportunity costs associated with two goods
a) Inefficient and unemployed resources operating inside the PPC
b) Outward shift indicates economic growth
5) Economic Resources & payments
a) Land all natural resources (raw materials) PAYMENT = RENT
i) Ex: beach, crude oil, timber, oceans, mineral deposits
b) Capital equipment and machinery (used to create goods) PAYMENT = INTEREST
i) Ex: computers, buildings, assembly line machinery
c) Labor intellectual and manual human attributes (human resources) PAYMENT = WAGES
d) Entrepreneurship PAYMENT = PROFITS
6) Rent the money one pays to use someones land
7) Interest the money one pays to use someones capital
8) Opportunity Costs are forgone or missed opportunities, tradeoffs, what one gives up to
purse the next best alternative
9) Opportunity Cost
i) Butter
Milk
(1) 0
10
(2) 10
5
(3) 20
0
ii) To determine opportunity cost divide 10 lbs of butter by 5 gal of Milk = 2
10)
Opportunity Costs found by adding explicit costs and implicit costs
a) Explicit cost you have to pay for access to the system (money well spent)
b) Implicit you have to spend time studying (time well spent)
11)
Absolute Advantage produce more of a good than another
12)
Comparative Advantage produce a good at a lower opportunity cost
13)
Normative economics based on the way someone believes Things ought to be opinions not facts
14)
Positive Economics states facts based on empirical evidence, forms a hypothesis and
tests it using scientific evidence
15)
Command Economy the government dictates production and consumption
16)
Free Market Economic System aka Capitalism supply and demand determine price of
goods
17)
Mixed Market Economic system - blends free market (capitalism) with the government run
(command system)
18)
Adam Smith Scottish economist - father of modern economics, wrote The Wealth of
Nations in 1776
Supply and Demand
19)
Law of Demand
a) Increase in Price (P) = decrease in quantity (Q) demanded
b) Decrease in Price (P) = increase in quantity (Q) demanded
i) Demand is the relationship between the amount of goods that a consumer is willing
and able to buy at the price
ii) Inverse relationship between price and quantity

20)
When demand decreases: market equilibrium price and quantity decreases
21)
Relative Price the price of one product expressed in terms of anther product
a) Calculate relative price by dividing one by the other
i) An iPod is $100, Tv is $500 the Tv is 5 ipods
ii) $10 movie ticket and $100 NBA ticket = relative price of NBA ticket is 10 movie tickets
22)
Externality is the impact (cost or benefit) of a transaction on a party that is not directly
involved in the transactions
a) Positive externality benefits people not directly involved
b) Negative externality causes harm for people that are not directly involved
i) Company dumps toxic waste in water supply, someone smoking in a restaurant,
construction noise, neighbors barking dog
23)
Positional Externality occurs when one party attempt so one up the other
a) Jim buys wife a $1000 ring, friend Jon buys his wife a $2000 ring
24)
Substitute Goods - goods that can be used in place of the other
a) Pepsi & Coke
25)
Complementary Goods Hot dogs and hot dog buns
a) When the price of one rises or falls the demand for the complimentary goods will also rise
or fall
26)
Law of Supply direct positive relationship between quantity supplied and price
a) Increase in price (P) = increase in quantity (Q) supplied
b) Decrease in price (P) = decrease in quantity (Q) supplied
27)
Supply is the relationship between price of the good and amount of a good a firm is willing
and able to produce
28)
Supply Curve Upward positive slope
a) Slopes upward due to the direct relationship between quantity and price
29)
Moral Hazard when people make less of an effort to avoid misfortune
a) When someone doesnt honk when a crash will occur because he wants to sue the owner
30)
Rational Self Interest Adam Smith
a) Producers of goods and services that act in their own self interest will improve public
welfare or public interest
i) Ex: construction worker who builds a road, gets paid benefits him, others use the road
benefits them
b) Invisible Hand Theory by doing what is best for us, we ultimately do what is best for
society
i) Invisible hand guided the free market towards public goods
ii) The free markets thrive on the basis of mutual self interest
31)
Inferior Products Walmart soda demand is increased when income is decreased
32)
Griffen an inferior good that does not have a substitute (bread)
33)
Normal Products aka Superior Goods - Coke & Pepsi demand is increase when income is
increased
34)
a)
b)
c)

Veblen goods snob goods, luxury cars, high end wines - status purchases
Decrease in price causes a decrease in demand
do not follow law of demand
known as conspicuous consumption

35)

Barter a direct exchange without using money

36)
Price Floor (5) = surplus(7) price cannot go below (floor stops it)
a) Consumers must pay more than market, they no longer purchase
b) Companies are guaranteed higher prices and produce more
37)
Price Ceiling (7)= shortage (8) price cannot go above (ceiling stops it)
a) Shortage because suppliers cannot charge market prices so they produce less
b) Consumers can buy the same produce for less so they purchase more
i) (remember this by letter counts match - more letters in the words 7/8 -ceiling and
shortage, less letters in the words 5/7 floor and surplus) also C- comes before F in the
alphabet so at the bottom is C of the equilibrium, at the top of the equilibrium is F.
38)
Market Equilibrium where quantity supplied equals quantity demanded
a) Equilibrium cannot occur when there is a price ceiling or floor.
39)
Marginal Opportunity Cost the amount of another product you give up producing to one
more unit of product
a) Ex: if producing another pair of jeans means you produce 3 less shirts, the marginal
opportunity cost of the jeans is 3 shirts
40)
Scarcest Resources diamonds, platinum, gold
a) Most expensive due to limited supply
b) Used conservatively
Elasticity
41)
Price Elasticity of Demand (PED) a mathematical formula to determine how much a
change in price affects the quantity demanded
a) The equation is % change in quantity demanded divided by % change in price
i) Ex: if a 20% off sale increased quantity demanded by 60%, = price elastic
(1) 60/20=3
(a) If the Price Elasticity of Demand (PED) is equal to 1, demand is unit elastic
(b) If the Price Elasticity of Demand (PED) is greater than 1, demand is elastic
(sensitive to changes in price)
b) Applies to both supply and demand
i) Inelastic Demand the quantity demanded rises or falls by a lesser % than the price
c) An increase in price results in a increase in total revenue, demand is Inelastic
d) When the demand is price inelastic, raising the price will increase revenue
i) Elastic Demand the quantity demanded rises or falls by a greater % than the price
e) When demand is price elastic, even a small decrease can greatly increase revenue
i) Inelastic Supply the quantity supplied does not increase or decrease by as large a %
as the price
ii) Elastic Supply the quantity supplied increases or decreases by a greater % than the
price
f) Graphically speaking if price and demand were a square box with the demand curve
intersecting from top left downward to bottom right, the left half below the demand curve
is price inelastic and the right half above the demand curve is elastic
price

g) SPLAT
i) Substitutes if there are substitutes, the demand is more elastic
ii) Proportion of Income the higher the price of the good, the more elastic
iii) Luxury vs. Necessity necessity (food) are inelastic we have to have it, while luxuries
(sports cars) are elastic we want it
iv) Addictive the more addictive a product is the more inelastic it is (cigarettes)
v) Time the longer a consumer has to consider the purchase, the more elastic
h) A Price - Quantity - L - graph with a straight HORIZONAL line in the middle is a graph that
demonstrates perfectly elastic demand.

i) A perfectly elastic demand is represented by a horizontal line

ii) Slope = zero
iii) If a good is perfectly elastic, even a small increase in price will cause the demand to
drop to zero
i) A Price - Quantity - L - graph with a straight VERTICAL line in the middle is a graph that
demonstrates perfectly inelastic demand.

i) Perfectly inelastic demand is represented by a vertical line

ii) Slope = infinity
iii) Changes in price do not effect demand
42)
Unit Price Elastic when the total revenue (TR) is the same regardless of price
a) When an increase or decrease in prices does not change the total revenue (TR) = Unit
elastic
i) 1.00 x 100 = 100
ii) 2.00 x 50 = 100
43)
Cross-Price Elasticity of demand measures the effect that a change in the price of one
good has on the price of another good
a) Cross Price Elasticity of Demand = % of change in the quantity demanded for good X
divided by % change in price of good Y
b) Negative cross-price elasticity when the demand of two goods are complements
c) Positive cross-price elasticity when the demand of two goods are substitutes
44)
45)
46)
a)

Utility the satisfaction a consumer receives as a result of purchasing a good or service

Marginal Utility is the satisfaction from each additional unit consumed
Total Utility the satisfaction received from all of the product consumed
When total utility is maximized marginal utility is zero

47)
Diminishing Marginal Utility
a) Ex: all you can eat buffet, not as much satisfaction is received from the last plate as the
first plate

48)
Reservation Price amount that a consumer is willing to pay for a good
a) Difference between reservation price and actual price is consumer surplus
49)
Consumer Surplus graphically illustrated ABOVE the market price and below the demand
curve the triangle above the market equilibrium price
a) The difference between what a consumer is willing to pay and what he actually paid
i) Willing $10 actually paid $3 = $7 consumer surplus
50)
Producer Surplus graphically illustrated ABOVE the market price and above the supply
curve the triangle above the market equilibrium price
51)

Total Revenue (TR) = Price (P) x Quantity (Q)

52)
Deadweight the total surplus (producer + consumer surplus) lost as a result of taxes,
market imperfections or other factors
a) a loss when the price is increased above market level and results in a loss to both the
consumer surplus and producer surplus
Wages and Labor
53)
Transfer Payments Medicaid, Medicare, social security, food stamps, housing assistance,
welfare
54)
Lorenz Curve economists consider this to be a measure of social inequality
55)
Gini Ratio another measure of social inequality
a) Gini ratio of zero (0) means each family has equal income
b) Gini ratio of 1, means that one family is receiving 100% of the income in society
56)
Income Effect a change in consumption (up or down) as a result of a change in real
income
57)
Real Income is actual income adjusted for all other factors including increasing prices of
goods and services as well as inflation
58)
Non-Rival Good - is a good that has zero marginal cost for providing the good to additional
consumers
59)
Rival Goods Private goods, T.V.
60)
Non-Exclusive Good Common Goods, and Public goods
a) is a good everyone has access to (no one can be excluded)
61)
Excludable Private Goods and Club goods

62)
63)

Rival
Non-Rival

1. Excludable
Private Goods (cars)
Club Goods (cable t.v.)

Non-Exclusive
Common Goods (national parks)
Public Goods (national defense)

64)
Public Goods aka Collective goods
a) Ex: national interstate system, military (national defense), education, law enforcement
i) People do not pay for public goods, they are available to everyone
b) Non-rival and Non-exclusive
65)
Progressive Tax increases as income increases
a) Most effective way to deal with income disparity
66)
Proportional Tax aka Flat Tax has no effect on income inequality
a) Ex: 20% tax for everyone
67)
Regressive Tax a tax that imposes equal amounts on employees and employers

a) Ex: social security

68)
Prospective Payment System (PPS) a system implemented in 1980s as a result of rapid
healthcare costs that pays the same amount (one price) to hospitals and doctors based on
the service.
a) A preset reimbursement rate
69)

Total Physical Product (TPP)

70)
Marginal Physical Product (MPP) - the extra output gained by one more unit of input
a) Examines the TPP prior to adding a unit of input and again after adding a unit of input
b) MPP = TPP (after unit is added) TPP (prior to adding unit)
71)
Marginal Revenue Product (MRP) is additional revenue that can be earned by adding one
unit of labor
a) As long as marginal revenue is greater than or equals one unit of labor, the firm should
hire additional worker
b) A firm should continue to hire workers until:
i) MRP = Wages (W) (marginal revenue product = wages)
c) Since Wages (W) is the same thing as Marginal Expenditure (ME), the formula can also
read:
i) MRP=ME (marginal revenue product = marginal expenditure)
d) An increase in the price a firms product will increase the firms demand for labor
72)
Positive Number - Marginal Physical Product if the total output of a product does increase
when variable resources are added, such as labor
73)
Negative Number Marginal Physical Product if the total output decreases when variable
resources are added.
74)
Average Physical Product (APP) - average amount produced per worker, it does not look at
marginal physical product (MPP)
a) Found by dividing the total amount by the number of workers
i) 1 worker = 20 loaves
ii) 2 workers = 33 loaves
iii) 3 workers = 43 loaves
iv) 4 workers = 49 loaves
v) 5 workers = 50 loaves
(1) APP = 10 loaves (50/5)
(2) With 5 workers the MPP is one loaf of bread
(3) The diminishing returns occurs when the 3 rd worker is added
(4) TPP increased after adding each worker
75)
Law of Diminishing Returns if adding an additional worker does not provide as great a
benefit as adding the last worker
a) When does the law of diminishing returns begin?
i) 1 worker produces 15 units (+15)
ii) 2 workers produce 35 units (+20)
iii) 3 workers produce 40 units (+5)
iv) 4 workers produce 44 units (+4)
b) When the 3 worker is hired
76)
Herfindahl Index measures whether an industry is a monopoly or perfectly competitive
a) Used by the Federal Trade Commission and Justice Department to evaluate whether or not
a monopoly is present

i) Herfindahl index of zero (0) is perfectly competitive

ii) Herfindahl index of 10,000 indicates a monopolized industry

77)
78)
79)
80)
81)
82)

Total Costs ( TC)

Total Variable Costs (TVC)
Average Variable Costs (AVC)
Fixed Cost (FC)
Wages (W)
Quantity of Labor (QL)

83)
Fixed costs are $75 and 3 workers earn $150 per day, determine the total costs and
average variable costs of producing 30 units
84)
a)
b)
c)
85)
a)
b)
c)
d)
e)

Total Costs = $525

TC = FC + (QL x W)
TC = $75 + (3 x $150)
TC = $525
Average Costs = $15
TVC = TC FC
TVC = ($525 - $75)
TVC = $450
AVC= $450/30
AVC = $15

86)
Public Interest Theory when government regulates/intervenes with the business markets
it is protecting the best interests of society
87)
Taxation the main method the Federal government addresses the income disparity
a) USA uses a progressive tax system, the wealthier pay more, which helps redistribute
wealth
Firm Basics
88)
Average Fixed Cost (AFC) fixed costs remain the same whether 1 or 100 products are
produced
a) Continuously decreases as the output increases
b) When a firm increases production, the average fixed costs will always decrease ??
c) Slopes down
d) Bottom downward sloping line on the price/quantity graph
i) Fixed cost include rent, insurance, mortgages, and equipment
89)
Average Total Cost (ATC) if process are set below this curve the firm loses money
a) But they can continue operations in the short run
90)
Total Costs are calculated by adding total variable costs (TVC) and total fixed costs (TFC)
together
a) TC=TVC + TFC

91)
Marginal Cost (MC) the increase in total cost when one unit of output is added
a) how much does it cost to produce the additional unit?
i) 0 units - $35
ii) 1 unit - $44
iii) 2 units - $52
iv) 3 units - $59
v) 4 units - $64
vi) 5 units - $71
vii) 6 units $79
b) What is the marginal cost to produce the 4 th unit = $5
i) TC of unit 4 minus TC of unit 3
ii) $64-$59= $5
92)
Total Fixed Cost (TFC)
a) If a baker can produce $100 cakes for an average total cost of $16. His average variable
cost (AVC) is $10. What is the total fixed cost (TFC) ? = $600
i) TC = 100 x $16 = $1600
ii) TVC = 100 x $10 = $1,000
iii) TFC=TC ($1600) TVC ($1000)
iv) TFC = $600
(1) To also find AFC simply divide the $600 by 100 (quantity produced)
(2) AFC = $6
(3) AFC=TFC/Q
v) Fixed costs are the same regardless of the number of units produced, if the cost to
produce 0 units is given this is the fixed cost.
b) If the firm is producing 5 units of output, the Average Fixed Cost (AFC) is? $7.00
i) 0 units - $35
ii) 1 unit - $44
iii) 2 units - $52
iv) 3 units - $59
v) 4 units - $64
vi) 5 units - $71
vii) 6 units $79
(1) AFC = TFC / Q
(2) AFC = $35 / 5
(3) AFC = $7.00
viii) Remember the TFC are the costs associated with zero units of output
93)

b)
c)
d)
e)

What is the Average Variable Cost (AVC) if the firm is producing 3 units of output? $8.00
i) 0 units - $35
ii) 1 unit - $44
iii) 2 units - $52
iv) 3 units - $59
v) 4 units - $64
vi) 5 units - $71
vii) 6 units $79
Total Variable Costs = Total Costs ($59) Fixed Costs ($35)
Total Variable Costs = 24
Average Variable Costs = TVC ($24)/Quantity (3)
AVC = $8.00
i) Average variable Costs will fluctuate based on the number of units produced

94)
Economic Profits = Total Revenue (TR) (explicit + implicit costs)
a) Economic Profits Method includes opportunity cost (implicit and explicit costs)
i) Ex: of implicit costs: owner working for free, owner investing in capital, or using
personal resource
(1) Implicit Costs are the opportunities foregone to run a business
ii) Ex. of explicit costs: wages, rent, materials
iii) If Jim spends 2 hrs building a table instead of working at his $20 hrs job, the supplies
for the table cost $45, and he sells the table for $100. Jims Economic Profits are:
(i) Economic Profits = Total Revenue (explicit + implicit costs)
(ii) Economic Profits = $100 85 ($45 (supplies) + $40 ($20 per hr wages x 2
hrs))
(iii)Economic Profit = $15
b) Accounting Profits = total revenue explicit costs (does not include implicit cost)
i) Ex. of explicit costs: wages, rent, materials
ii) If Jim spends 2 hrs building a table instead of working at his $20 hrs job, the supplies
for the table cost $45, and he sells the table for $100. Jims Accounting are:
(a) Accounting Profits = Total Revenue (minus explicit costs )
(b) Accounting Profits = $100 45 (supplies)
(c) Accounting Profit = $55
95)
Negative Economic Profits occur when total costs (including opportunity costs) are
greater than revenue
96)
ATC = ATC + AFC
a) Average Total Cost is equal to the sum of average fixed costs (AFC) and average variable
cost (AVC)
i) Ex of fixed costs: rent, equipment, taxes, insurance
ii) Ex of variable costs: labor, utilities, and production related materials
b) The average total cost curve ATC curve ALWAYS intersects the AVC and ATC at the lowest
points
97)
Average Total Cost (ATC)
a) When they produce 4 units of output (below) the ATC per unit is ?
i) 0 units - $35
ii) 1 unit - $44
iii) 2 units - $52
iv) 3 units - $59
v) 4 units - $64
vi) 5 units - $71
vii) 6 units $79
b) Average Total Cost (ATC) can be found using this formula
i) ATC = TC/Q
ii) ATC = $64 / 4
iii) ATC = $16.00
98)
Total Cost
a) TC = (AVC + AFC) / Quantity ??
99)
Average Variable Cost (AVC) - if prices are below the minimum point on this AVC curve
the firm should shut down
100) Economies of Scale decreased costs per unit as a result of increased production
a) Example: when a firm doubles its input and triples output (lower ATC)

i) If a firm triples input and triples output neither (equal ATC)

ii) If a firm quadruples its input and triples output diseconomy of scale (higher ATC)
101) Diseconomies of Scale when increased output leads to increased per unit costs
102) Short Run a period of time during which some of the expenses are fixed and supply
cannot fully adjust to changes in demand
a) Fixed costs do not change in the short run
103) Long run there is no such thing as fixed costs ALL costs are variable, supply has
adjusted to changes in demand
104) Optimum Profits a firm should produce at a point where
a) Marginal Revenue (MR) = Marginal Costs (MC)
b) Firms should produce up to the point where: Marginal Revenue (MR) = Marginal Cost (MC)
i) Q1 to increase profits, increase production
ii) Q2 profits are maximized (MC = MR)
iii) Q3 to increase profits, decrease production
105) Normal Profits is the minimum profit necessary for a firm to survive in a perfectly
competitive market
a) Markets with normal profits will neither expand or shrink, they are in a state of long-term
equilibrium
b) In a free market normal economic profits are Zero
106) When Marginal Revenue (MR) is below ATC, the firm is losing money
a) The firm is selling products for less than it costs to produce
b) Firms should produce up to the point where: Marginal Revenue (MR) = Marginal Cost (MC)
107) Breakeven points for a firm is where?
a) The point that lays at the intersection of the Average Total Cost (ATC) and the marginal
cost (MC)
i) ATC all costs divided by quantity
ii) MC the cost to make one additional unit
108) Marginal Revenue is the amount of revenue that is generated by selling one more unit
a) MR = Total Revenue / Total Quantity (Q)
109) Rules of Normal Profits:
(1) A firm will only achieve normal profits in the long run
(2) A firm that has sub-normal profits will probably close shop in the long run this will
drive up profits
(3) A firm that has super-normal profits will attract new competition
(a) Firms enter in the long run and drive profits down
b) Lower than normal profits are known as sub-normal and firms exit the market
110) Shut Down Points :
i) Long Run the minimum price point is Average Total Cost curve (ATC)
(1) If the price drops below the minimum on the ATC curve, the firms cannot make
money and will shut down
ii) Short Run the minimum price point is on the Average Variable Cost curve (AVC)
111) Average Fixed Costs (AFC) = Total Fixed Costs (TFC) divided by Quantity (Q)
112) Total Revenue Total Cost = Profit

a) A firm must maintain a large difference between the cost of production and revenue
b) The optimum level of production is:
i) MR (marginal Revenue) = MC (marginal Cost)
113) Marginal Cost (MC) curve will ALWAYS cross the Average Total Cost (ATC) curve at the
minimum average variable cost (AVC) curve
114) Marginal Cost (MC) is the increase in total cost that occurs when one unit of output is
added
a) In contrast Marginal Revenue (MR) is the additional revenue from one unit increase in
output
Perfect Competition
115) In a perfect competition, Price (P) = Marginal Cost (MC)
a) P=MC simply means that the price that a firm is selling their product is equal to marginal
cost to produce
b) Price of a product is equal to minimum average cost
116) Normal profits mean Zero .00 economic profits
a) Normal profits occur when Price (P) = Average Total Cost (ATC) at the bottom of the ATC
curve
117) Long Run equilibrium dictates perfectly competitive firms have an economic profit of zero
aka, normal profit.
a) When firms are making an economic profit new firms enter the market and drive profits to
zero
b) When firms are losing money, firms exit the market and prices go up
i) Due to barriers of entry, a monopoly can generate greater than zero economic profits
c) In the long run firms enter and exit a perfectly competitive market until firms are earning
zero economic profits (normal profits)
118) Long Run Equilibrium occurs in a perfectly competitive firm when Average Total Cost (ATC)
is at the minimum point on the ATC curve
(1) In Long Run equilibrium all of the following apply:
1. Quantity Demanded = Quantity Supplied
2. Zero economic profits are made
3. Optimum Production level is Marginal Revenue (MR) = Marginal Cost (MC)
4. Price (P) = Minimum Average Cost
5. Price (P) = Marginal Revenue
119) Short Run in the short run profits and losses can be made by firms
a) To maximize profits and minimize losses firms should produce at a level where Marginal
Revenue (MR) = Marginal Cost (MC)
b) When perfectly competitive firms earn Short Run economic profits, more firms enter the
market
120) Firms primary decision is the Quantity (Q) to produce
a) Marginal Revenue(MR) = Marginal Cost (MC) = optimum production Quantity (Q)
121) Price-Takers firms must sell at the market dictated price
122) Barriers to entry anything that makes it difficult for new firms to enter the market
a) Example: political, legal and regulatory

b) With perfect competition, barriers are minimal or non-existent

123) Perfect Competition a market that has many firms providing many buyers with the same
product

124) Characteristics of perfect competition are:

(1) There are many firms and many consumers selling the same products
(2) Each firm is a price-taker (firms are unable to influence price causes horizontal
demand)
(3) There are no barriers of entry
(4) Both the consumers and firms have perfect information (all consumers and
producers know the price and quality of all the competitions products)
(5) Each firm selling the same product
ii) It is difficult to influence the market due to the large number of firms and consumers in
perfect competition market
iii) Firms do not advertise in a perfectly competitive market
(1) Products are homogeneous (the same) no need to differentiate one producers
peaches from anothers peaches.
125) Demand Curve
i) Horizontal for a firm implies perfect elasticity and any increase in price would result in
zero demand for the firms product, the firm is a price taker not a price maker
ii) Downward sloping in the markets demand
126) Product Markets
(1) Perfect Competition many firms selling a product
(2) Monopolistic Competition quite a few (more than oligopolies and monopolies)
(3) Oligopoly there are few sellers who are interdependent
(4) Monopoly one seller (no close substitutes)
ii) The more competition a firm faces the more efficient the firm becomes
Imperfect Competition
127) Monopoly prices are higher than Marginal Revenue (MR)
128) Monopoly one firm who makes up an entire industry no substitutes
a) Barriers make it virtually impossible for new firms to compete
b) Monopolist are price makers and will charge whatever the market will bear
129) Criteria for Illegal Monopoly
(1) Inelastic demand increase in price does not decrease demand
(2) Not Cross-Elastic no valid substitutes for the product (Ex. gas)
(3) Market Share is greater than 70%
(4) Illegal use of the monopoly power
130) Legal Monopolies aka Natural Monopoly - Utility Companies
i) Entry into the market has such a high cost that tow competing firms could not make
money
(1) t is illegal to compete against a legal monopoly

ii) Most common type is one who holds a patent or permit, preventing other firms from
competing
iii) Less common is a monopoly that has law designed to protect it from competition
(1) Example: U.S. Post Office
b) Meet the first three criteria for an illegal monopoly
c) If they raise prices unreasonably or without cause they would be subject to antitrust laws

131)
a)
b)
c)

Sherman Antitrust Act of 1890 makes actions that restrain trade illegal
Price-fixing
Production quotas per se violation agreement to restrict supply to increase price
And agreements between competitors that cartels use to influence demand

132) Clayton Antitrust Act of 1914- created to address the rule of reason and actual adverse
impact loopholes in the Sherman Act of 1890
a) Clayton Act - Most famous for prohibiting mergers and acquisitions that create monopoly
or reduce competition
133) Rule of Reason antitrust doctrine, which originated from a U.S. Supreme Court ruling
(1911) allows restraint of trade if:
(1) There is a legitimate business purpose
(2) Trade is economically efficient
ii) When economically efficient and related to valid business purposes, the rule of
reason allows unintentional and reasonable restraints of trade
134) Interlocking Dictatorship when a person serves as the director of two or more competing
companies
a) Prohibited by the Clayton Act of 1914
135) Vertical Agreements with antitrust concerns are:
(1) Tie-in Agreement customers have to buy a product (they dont want) to get
another product
(2) Price Discrimination different people are charged different prices for the same
product
(3) Exclusive Distributor only one distributor can sell a product
(4) Exclusive Dealing a distributor can only sell one manufacturers product
ii) Vertical agreements are agreements with the buyers and sellers.
136) Horizontal Agreements an agreement between two businesses that are in competition
a) A per se violation of the Sherman Act
b) Reduces competition
137) Per Se violation an action that is considerer anti-competitive and intrinsically illegal
a) Examples of per se violations:
(1) Price Fixing - when several competitors agree to raise the price of a product
results in a higher price than the market can bear
(2) Price Discrimination - when a firm charges two parties different prices for the exact
same product or service
138) Potential Entrant Effect - when the potential of a new competitor drives businesses to
efficiency and lower prices for the consumer
i) Conglomerate Mergers can be challenged on the basis of Potential Entrant Effect if:
(1) The threat of potential entrant influenced the industry

(2) Company could have entered the market without the merger taking place
(3) The number of potential entrants is small
ii) The problem with mergers and acquisitions is it can eliminate the potential entrant
effect
139) Group Boycotts per se violations of the Sherman Act of 1890 occurs when a group of
companies pressure a manufacturer to terminate its relationship with one company
a) Definitions
i) Group Boycott because of pressure from many retailers, a manufacturer decides to
not longer sell to an individual retailer
ii) Refusal to deal a manufacturer decides to no longer sell to a retailer
140) Market Division is when competitors in the same industry divide up a large territory into
segments,
a) Restricts customers access to a free market
i) by dividing the territories they create monopolies
ii) a per se violation of the Sherman Act of 1890,
iii) Also known as Horizontal Territorial Limitations
141) Monopolistic Competition is the most prominent type of market structure in the United
States
a) Monopolistic competition is inefficient due to excess capacity
i) Ex: a restaurant that is only busy at lunch
ii) Produces less output than perfect competition and the output it produces is at a higher
price
b) In the long Run a monopolistic competitor will make normal profits (economic profits are
zero in the long run) similar to a perfect competitor
i) With one difference:
(1) Monopolistic Competition: Price (P) = Average Total Cost (ATC) NOT at Minimum
(2) Perfect competition: Price (P) = Average Total Cost (ATC) at the Minimum
ii) Since monopolistic competition is inefficient
(1) Price (P) is greater than Marginal Cost (MC)
(2) Goods and services are priced at a higher level than the cost to produce
142) Game Theory a mathematical analysis of the strategic moves and counter-moves that
occur in an oligopoly market
143) Cartel multiple firms acting together as one firm
a) Example of Cartel - OPEC group of 11 major oil producing countries who attempt to
control oil prices by limiting production
i) Eliminates competitive pricing
ii) Increases the firms price/profits
(1) Cartels were made illegal in the U.S by the Sherman Act of 1890
iii) Cartels are not stable since there are incentives within a cartel to cheat
144) Imperfect Competition is inefficient
(1) they can survive unlike Perfect Competition, efficiency is a requirement for longterm survival
(2) produce output level where the Price (P) is greater than Marginal Cost (MC)
(a) when price is greater than MC the firm is inefficient
145) Marginal Revenue
a) Joe has a monopoly of tea, he sells 25 glasses of tea for $1 each, If he wants to sell 26
glasses, Joe can only charge $.97 per glass. What is the Marginal Revenue on the 26 th
glass of tea sold?

i) First determine total revenue for 25 glasses and 26 glasses, and then determine the
difference between the two.
(1) P1: 25 x $1.00 = $25.00
(2) P2: 26 x $.97 = 25.22
(3) P2- P1 = MR
(4) 25.22 25.00 = $.22
(5) MR on the 26th glass is $.22

146) Oligopoly Characteristics

(1) Product Branding
(2) Entry Barriers anything that makes it difficult to enter the market
(a) Ex: other brands, patents, copyrights, trademarks, and cost
(3) Interdependent decision Making (most important characteristic of oligopoly)
(a) If one Cell phone company lowers prices the other must, price wars do not lead
to increased demand, they lead to decreased revenue for each firm.
(b) For interdependent decision making to be effective the number of firms in the
oligopoly must be small
(c) This firms are the price makers and must strategically consider the reactions of
the other firms in the market
(4) Non-price competition by providing higher quality products or characteristics
(a) Ex: warranties, return-policy, store hours, things that match the consumers
preferences
(i) In the USA a current oligopoly is the Cell Phone industry
1. Dominated by a few interdependent producers
2. Very difficult to enter the market
ii) When 5 or less make up 60% of a market, it is considered an oligopoly
147) Kinked Oligopoly Demand Curve when competing firms follow price decreases but not
price increases
a) Assumptions made regarding the kinked demand curve:
(1) If one firm raises its price, competition likely will not raise their prices in fear of
losing market share
(2) If a firm lowers its price, competitors will follow, so they do not lose market share
b) Things to remember
(1) The firms Marginal Revenue (MR) has a gap at the kink 2
(2) Prices above the current price are relatively elastic
(3) Prices below the current price are relatively inelastic
148) Federal Trade Commission (FTC) works with the Justice Department to protect free trade
a) FTC handles civil actions
b) U.S. Justice Department can handle civil and criminal actions
i) They have the power to:
(1) Break up firms
(2) Discourage through taxation
(3) Price floor
(4) Price ceilings
(5) Prevent mergers
ii) Granted these powers through the Sherman Act
c) Can exercise power through:

i)
ii)
iii)
iv)

Advising counsel regarding legality

Consent decrees FTC agrees not to fine a business if they cease
Cease and Desist Orders tells a business to stop breaking laws or face fines
Extreme Measures order a business to sell off assets or dissolve itself

149) Federal Trade Commission Act of 1914

a) Outlawed
i) unfair or deceptive business practices
ii) Unfair methods of competition
b) Created a commission to investigate and enforce
150) Competition causes firms to be efficient

151) Perfect Competition markets have:

(1) The most substitute products available
(2) The most elasticity
(3) Largest number of sellers
(4) Firms that are price- takers
(5) THE GREATEST OUTPUT!!
152) Barriers affect different market types:
i) Perfect Competition no barriers to entry or exit
ii) Monopolistic Competition weak barriers may exist
iii) Oligopoly large barriers prevent most entry
iv) Monopoly complete barriers prevent all entry
153) Nash Equilibrium is a strategy that requires each firm to base its decisions on the
strategies of other firms
a) Seeks a point where each firm gains the same amount of utility