Econ Exam 1 Flashcards
Economic Assumptions of Perfectly Competitive Market
1) firms are price takers (large #, sell identical products, full info on both sides, low transaction costs, firms can freely enter/exit market)
2) cannot sell above market price
3) perfect mobility of production factors
4) no externalities
Production Function
q= f (L, K), usually K is fixed in the short run, lariable labor
Marginal Product of Labor
MPL= dq/dL = d [f (K,L)]/ dL “additional output produced by an additional unit of labor”
Average Product of Labor
APL = q/L “ratio of output to unit of labor”
Relationship between APL and MPL
APL max. when APL= MPL, both rise at first, but when MPL crosses over APL, they both fall, a firm will only operate if MPL is positive
Law of Diminishing Marginal Returns
holding all other inputs + tech constant an increase in input will lead to diminishing increase in output
Long Run
K and L variable
Isoquant
curve of efficient combinations of inputs for fixed amount of q (cardinal not just ordinal)
Properties of Isoquant
- farther from origin= greater level of output
- cannot cross
- downward slope
- thin
Reinstatement Effect
technology requires new kinds of labor but labor still has comparative advantage (e.g. cyber security jobs)
Perfect Substitutability Isoquants
Isoquants that are straight line (demand direction)
Fixed Proportions Isoquants
Right angle isoquants (e.g. Leontief, workers and lawnmowers
Marginal Rate of Technical Substitution (MRTS)
“how many unites of K the firm can replace with extra unit of L”, MRTS= change in K/ change in L
MRTS= dK/dL = -MPL/MPK
instantaneous slope of isoquant line
Basically the MRS but the two goods are L and K
Why does MRTS diminish along convex isoquant?
the more L a firm employs the fewer K would be needed to replace, if firm employs very little L, you would need a lot of K to replace one unit of L
What measures the curve of the isoquant?
Elasticity of Substitution (K and L)
d(K/L)/dMRTS [MRTS/(K/L)]
Types of Elasticity of Substitution (K and L)
omega = 1/1-price
Linear: omega = infinity
Leontief: omega approaches 0
Cobb Douglass: omega = 1
Constant Returns to Scale
x% increase in input yields x% increase in output
Test: f(2L + 2K) = 2 f(L, K)
Increasing Returns to Scale
increase input yields greater increase in output
Test: f(2L + 2K) greater than 2 f(L, K)
Usually happens with specialization
Decreasing Returns to Scale
increase input yields less increase in output
Test: f(2L + 2K) less than 2 f(L,K)
Usually happens when organizing/coordinating production is difficult
Explicit Cost
direct out-of-pocket (part of opportunity cost)
Implicit Cost
reflect a foregone opportunity (part of opportunity cost)
Opportunity Cost
Value of “best alternative”
Total opportunity cost = explicit + implicit
*do not include sunk cost
Opportunity cost of capital
unclear, if rented it =rent
If $ could have been invested elsewhere, then it’s market rate return on investment
Short Run Total Cost Function
Total Cost = Vc (q) + F
Sunk Cost
not included in opportunity cost *need more details
Marginal Cost (MC)
Mc = dC(q)/dq *derivative of cost function wrt q
“additional cost as firm produces 1 more unit of output”
Average Fixed Cost (AFC)
F/q
Average Variable Cost (AVC)
VC/Q
C/q = AVC + AFC
Average Cost
AC = AVC + AFC
= cost/q
Relationship between Marginal and average costs in short run
MC = W (1/MPL) since labor is fungible in short run, MC and MPL are inversely related
Long Run Costs
everything is variable in the long run
Isocost
Combination of inputs yielding same total cost
C= WL + rK
or K = C/r -(w/r)L
Cost Minimizing
(MPL/W) = (MPK/R) bang for buck for labor and capital are equivalent
Economies of Scale
LRAC decreases as Q increases (from increasing returns to scale, can be from learning by doing)
No Economies of Scale
No change/ constant LRAC as Q increases
Diseconomies of Scale
LRAC increases as Q increases (usually result of decreasing returns to scale)
Economies of Scope
Cheaper to produce joint goods than seperately
How can you tell if something is in economy of scope?
SC= [C(Q1, 0) + C(0, Q2) - C (Q1, Q2)}/[C(Q1, Q2)
If SC greater than 0, join production is cheaper
if SC less than 0, join production more expensive
What is the shape of the Production Possibilities Frontier for an economy of scope?
Bowed away from origin
Profit Maximization Assumptions
- Firms are price takers
- both buyers and sellers have info about prices
- transaction costs negligible
- firms freely enter/exit market (but cannot sell above market price)
- firms face horizontal demand curve @ market price
Profit Function
Profit = Rev (q) - C (q)
Profit Maximization (solve for q)
Profit = Rev (q) - C (q)
To find profit max, take derivative of profit wrt q, set equal to 0, solve for q
Max is when MR(q)= MC(q)
In perfect competition MR=P
Short Run Shut-Down Decision
Shut down if revenue is less than variable cost
pq < VC
“if market price is less than min. of short run average variable cost”
ignore sunk cost- variable cost is the only that matters in shut down decision in short run
Long Run Shut Down decision
if expected profits < 0
shut down point = minimum of LRAC curve
Long Run Market Supply
Assuming identical firms, free entry, and constant input price
LR market supply is horizontal at min. LRAC
*LR market supply will not be flat if 1) entry limited, 2) firms differ, 3) input prices vary w/ output
Theory of Second Best
if an economy has two (or more) distortions alleviating only one may not improve welfare
Producer Surplus
Amount above supply below price “amount above marginal cost that suppliers would have supplied at but didn’t have to”
Deadweight Loss
foregone economic activity brought about by a market distortion; net loss to economic welfare
Price Support- Deficiency Payment
Government sets P and pays (p-market clearing price),
“gov pays difference between guarantee and market price”
