eco105 7-8 Flashcards
Depreciation
the decrease in value of equipment over time because of wear and tear and because it becomes obsolete
Obvious costs
also known as explicit costs, they are plain to see
Implicit costs
hidden opportunity costs of what a business owner could earn elsewhere with time and money invested
Accounting profits
Revenues - obvious costs (including depreciation)
Risk-loving
gamblers, might not require much risk compensation to go for the uncertain investment as long as the returns are just a bit higher than the guaranteed return
Risk-averse
more cautious, it would take a very high risk compensation to get you to go for the uncertain investment over the guaranteed bank investment
Normal Profits
compensation for the use of a business owner’s time and money, the sum of the hidden opportunity costs
time component of normal profits
the value of the best alternative use of the owner’s time
money component of normal profits
the best alternative return on investment, including risk compensation
Economic profits. =
revenues - (obvious costs + normal profits)
Economics losses
negative economic profits
Breakeven point
business just earning normal profits, no economic profits or losses
Short-Run Market Equilibrium
term used to describe a market where quantity demanded equals quantity supplied
When there are economic losses,
prices are not covering all of the business’s opportunity costs of production; consumers don’t value the product/service enough to pay the price that covers all business costs, including normal profits
When businesses exit the industry,
supply decreases, moving the market price up along the unchanged demand curve; businesses keep exiting, supply keeps decreasing, prices keep rising, and losses keep decreasing
Long-Run Market Equilibrium
term used to describe an industry where businesses have 0 economic profits; quantity demanded equals quantity supplied, economic profits are 0, no tendency for change
As new businesses enter the industry,
supply increases
Monopoly
Only seller of a product or service; no substitutes available
Market power
business’s ability to set prices; A monopoly has maximum power to set prices
Price maker
Pure monopoly with maximum power to set prices
The price maker’s goal
to find the price and quantity combination that yields the greatest profits
demand curve for a monopoly
steep and inelastic because there are no close substitutes
Perfect competition
many sellers producing identical products or services
Price taker
business with zero power to set prices; Profits are limited to normal profits
The best any business in perfect competition can hope for is to
recover all their opportunity costs of production, including normal profits → economic profits are 0
why does perfect competition have Perfectly Elastic Demand
- no matter how much you supply, the market will demand it
- you will find buyers for any quantity you can produce, and you don’t have to lower your prices to sell more
Market structure
characteristics that affect competition and pricing power
main characteristics that affect competition and pricing power
available substitutes, number of competitors, barriers to entry of new competitors
Available substitutes
How we define a market depends on how we define a particular product or service
The more broadly we define a market the more substitutes there are, and the more competitors there are → less pricing power
The more narrowly a market is defined, the fewer substitutes and competitors → more pricing power
Number of Competitors: pricing power
The fewer competitors, the more pricing power
The more competitors, the less pricing power
Impact on number of competitors caused by technology
Can be good as it allows for businesses to extend their market, selling services anywhere in the world consequently increasing sales
Can be bad as companies around the world can compete, which limits pricing power
For consumers, the internet’s explosion of competition is good → more choices and lower prices
Barriers to entry
legal/economic barriers preventing new competitors from entering a market
Legal barriers to entry
governments keep new competitors out of a market by passing laws, giving a business the exclusive right to supply a product/service
Patents
exclusive right to the inventor to supply his new product/service
Copyright
exclusive rights to creator of a literary, musical, dramatic, or artistic work
Average total cost
total cost per unit of output
Average total cost decreases as the business produces larger quantities of output
Economics of scale
average total costs of producing decreases as quantity (scale) of production increases
If a big business is already supplying most of a market, a new competitor trying to enter will start will lower sales and therefore higher average total cost → new business can’t compete on price
Product differentiation
attempt to distinguish product/service from those of competitors → fewer substitutes, more pricing power
Higher pricing power with inelastic demand
Businesses with the highest pricing power tend to have the most inelastic demand
With fewer substitutes, consumers have less choice and are in a weaker bargaining position
Businesses have more market power to be able to raise prices and still keep selling
Low pricing power with elastic demand
businesses with the lowest pricing power tend to have the most elastic demand
With more substitutes, consumers have more choice and are in a stronger bargaining position → businesses gave no power to raise prices
With perfect substitution there is no product differentiation or brand loyalty, so the demand for every supplier’s particular product is perfectly elastic
The higher the pricing power, the more ___ demand is; the lower the pricing power, the more ___ demand is
inelastic, elastic
Oligopoly
a market structure with a few big businesses that control most of the market
In an oligopoly with available substitutes, demand is more ____ than for monopoly, but more ___ than perfect competition
elastic, inelastic
Why are there barriers to entry in an oligopolistic market
Sellers are usually big, with economies of scale that make it hard for new competitors to enter
Monopolistic Competition
Many small businesses make similar but slightly differentiated products/services
Are there any barriers to entry in monopolistic competition
There are no barriers to entry, so the only hope for economic profits comes from the product differentiation that gives each business some slight pricing power or from producing at lower cost
What do businesses do to compete
- Cut costs
- improve quality and product innovation
- Build barriers to entry
What does competitive pressure do
Causes the matching of competitor’s actions usually means matching price cuts on existing products/services
Creative destruction
competitive business innovations generate economic profits for winners, improve living standards for all, but destroy less productive or less desirable products and production methods
