Chapter 7 Flashcards
How is demand defined?
How much potential consumers are willing to pay for its product
How are total costs calculated?
Unit cost * quantity
How is total revenue calculated?
Price * quantity
How is profit calculated?
Total revenue - total cost
How would you find the profit maximising point on isoprofit graph?
Where the slope of the isoprofit curve equals the slope of the demand curve
MRS=MRT
What is the feasible set on an isoprofit graph?
All area bellow the demand curve
What do a firms costs depend on?
It’s scale of production and they type of production technology it has
If input increases by a given proportion, and production increases more than proportionally then …
The technology exhibits increasing returns to scale in production
Economies of scale
If input and production increase proportionally then…
Technology exhibits constant returns to scale in production
If input increases and production increase less than proportionally then…
Technology exhibits decreasing returns to scale in production
Diseconomies of scale
What are cost advantages in economies of scale?
Large firms can purchase inputs on more favourable terms as they have greater bartering power when negotiating with suppliers
Some demand advantages in economies of scale are …
Network effects (value of output rises with number of users eg software applications)
What does the cost function show?
Shows how total production costs vary with quantity produced
How is average cost calculated?
Average cost is the cost per unit produced
Is the slope of the ray from the origin to a given point on the cost function
What is marginal cost?
The effect on the total cost of producing one additional unit of output
Calculated as the slope of the cost function at a given point
What statements are always true about the relationship between AC and MC?
AC> MC then AC is decreasing
AC
What does the demand curve represent?
The quantity that consumers will buy at each price
What do the isoprofit curves show?
The price-quantity combinations that give the same profit
What is constrained optimisation?
The objective of a firm is to optimise something (utility, costs, profit) but the decision maker faces a constraint which limits what is feasible (budget constraint, demand curve, feasible set)
What is marginal revenue?
Change in revenue from selling an additional unit (net effect of decreasing price and increasing quantity sold)
At what point will a firm be choosing the profit maximising choice?
Where MR=MC
What should a firm do if MR> MC?
The firm should raise Q (quantity) as profits would increase
If the marginal profit is negative what should a firm do?
MR
What is consumer surplus?
The total difference between willingness to pay and the purchase price
What is producer surplus?
Total difference between revenue and marginal cost
What is total gains from trade?
Total surplus (consumer surplus + producer surplus)
When is a point in the price quantity space said to Pareto efficient?
All trades which would give a positive surplus are realised
No deadweight loss
Total surplus cannot be increased by changing the level of production
What is deadweight loss?
A loss of total surplus relative to a Pareto efficient allocation (unexploited gains from trade)
The area between the demand curve and marginal profit that isn’t shaded
What is price elasticity of demand?
Measure of responsiveness of consumers to a price change
How is price elasticity of demands calculated?
ε=-%change in demand/%change in price
When demand is elastic what value should MR have?
Greater than one
If the demand curve is quite flat what would that mean for elasticity and why?
High elasticity because the quantity changes a lot in response to price changes
What does high elasticity mean?
That price will only fall a little if the firm increases its quantity
Products that would have a high elasticity include heinz soup, dairy milk
There are many alternatives so a change in price will cause a lot of people to jump brands
What types of products would be inelastic?
Petrol, salt, diamonds
Products that there are few alternatives for
How would a firm increase profit margins if the product had low elasticity?
They can raise price above marginal cost as there are few alternatives so people will still purchase the product
How can governments raise more tax revenue in terms of elastic or inelastic goods?
Levying taxes in price inelastic goods
Why is competition policy good for consumers?
It limits firms market power and helps stop firms colluding to keep prices high
What is a natural monopoly?
When one firm can produce at a lower cost than two or more firms
Why is monopoly rent an example of market failure?
As there is deadweight loss due to firms setting prices above marginal cost
How can firms increase their market power?
Innovating - allows them to differentiate products from competitors, can invent entirely new products and stop competition through patents or copyright laws
Advertising - attract mire customers away from competitors
