ECON130 Flashcards
The competitive model
Examins supply & demand
Assums that:
- Firms are interested in max profit
- Consumers are rational/self -interested
- Markets are perfectly competitive
Efficiency of competitive model
The allocation of resources predicted in the competitive model is efficient e.g.
- scarce produce is not wasted
- Not possible to produce more of one good without producing less of another good
- Not possible to make one person better off without making someone else worse off
Rationality
A rational decision is one where a decision-maker choose the option that gives them the best possible payoff subject to the constraints they face
Main characteristics of a competitive market
- many firms
- Selling identical products
- too many customers
General equilibrium
Concept where all markets are balanced and that supply equals demand in every market
- All consumers max utility
- All firms max their profit
When is a pareto efficienct?
An economy is pareto efficient if:
- An economy has its resources and goods relocated to the maximum level of efficiency & no changes can be made without making someone worse off
4 elements of consumer choice
- Consumer’s income
- Prices of goods
- Consumer preference
- Rationality
the budget set
All the different bundles of goods a consumer can afford
What does the budget line show?
shows the different bundles a person could buy when they spend all their income
Utility
The benefits derived from consuming a bundle of goods are called utility
When can two different bundles be represented using indifference curves
When the bundles have the same utility
Utility function
Evaluates a bundle according to a person’s preference
Sunk costs
Unavoidable costs
Marginal costs
Costs added by producing on additional unit of a product or service
Opportunity costs
The loss of other alternatives when one alternative is chosen
Production possibility frontier
An economic model showing the production possibilities of an economy when resources are maximised in production
What do point along & inside a curve (PPF) show
Along: show productive efficiency in the economy, where resources are fully utilised
Inside: show an economy that has not fully utilised its resources
What does the bundle of MUx/Px= MUy/Py mean
Means that the person derives the same satisfaction per $ of expenditure from each good
equi-marginal principle
The consumer should continue to adjust his consumption so that MUx/Px falls and Muy/Py rises until they are equal
Normal goods
Goods that experience an increase in demand when income rises
Inferior goods
Good which demand drops when income rises
Consumers do not always buy more of a good when their income rises. Consider an income increase
How can a price change impact the budget line?
- it alters the slope of the BL, reflects the change in relative prices (the substitution effect)
- it changes the real purchasing power of income - some bundles are no longer affordable (the income effect)
What determines costs?
Depend on the inputs a firm uses
- The productivity of factors of production
- The price of factors of production
- What can be changed - fixed/variable costs
Short-run costs
Cost of a product that has short term implications in the production process
Marginal costs (MC)
is the rise in total cost if output increases by 1 unit
Average cost (AC)
is the typical cost of a unit of output, for a particular level of output
Marginal product (MP)
Shows the additional output created as a result of additional input
MP = ?Y/?X
X =change in use of input
Y= Change in quantity of output
Input choice
level & mix of inputs will depend on the timeframe across which it is making decisions: short or long run
Production function
Explains relationship between physical inputs and outputs
outputs = number of goods/services produced in a given time
inputs = number of resources used to produce these outputs
What does the production isoquant show?
Line on a curve that shows combination of inputs that will produce a specific level of outputs
In the short run how do changes in the fixed costs impact competitive markets
changes to fixed costs do not affect a firm’s marginal cost of production
As long as min AVC < P, then a firm should continue to produce at the quantity where MR = MC
- Increase in fixed costs does have an effect in the short run it increases the firm’s total costs = reduced profit
In the long run how do changes in production impact competitive markets
- if a firm makes a loss it will exit the industry
- at an industry level this alters the price that the remaining firms face
- eventually they will return to making zero profit
If a perfectly competitive firm shuts down in the short run & exits the industry in the long run, the firms short run condition is
TR<TVC
TR = total revenue
TVC = Total variable cost
Perfectly competitive firms are… (3)
- Price takers
- Sell homogeneous products
- Small relative to the size of the market
The rising part of a perfectly competitive firm’s ____ cost curve is the firm’s short run ___ curve
- marginal
- supply
As a new firm enters an increasing-cost industry what happens to the LRAC curve
the LRAC curve shifts up
(Long run average cost)
As long as price is sufficient to cover____, the firm is better off by operating rather than shutting down
Average variable cost
Average variable cost
total variable cost per unit of output
In the long run firms will expand as long as there are more____ and new firms will enter the industry as long as they earn ____
- economics of scale
- Positive economics profits
If a firm shuts down in the short run what is equal to what?
Their losses are = to fixed costs
The best explanation for the slope of a short run marginal cost schedule is
A fixed factor causes diminishing returns to other factors
When does the profit-maximising output occur?
When MC= MR
Marginal cost = marginal revenue
What does the capital- to- labour ratio
This indicates how much capital is being used per unit of labour in the production process
Define production function
is a set of technically efficient production plans i.e. it gives the maximum amount of output that can be made given the specific inputs and available technology
Define marginal product
Extra output from the use of one extra unit of an input
Input choice
Level & mix of inputs will depend on the timeframe across which it is making decisions: short or long run
How can a firm achieve cost minimization?
A firm should use a mix of inputs so that it does not want to spend any more/less on either input i.e. it has the best mix of inputs for a given level of output
What does the production isoquant show ?
shows a set of efficient techniques that produce a given level of output
Profit maximisation in competitive markets
- Firms produce where the difference between total revenue and total cost is greatest
- This occurs when the slope of TR and the slope of TC are equal
- The slope of the TR curve is MR
- The slope of the TC curve is MC
Competitive firms maximise profits at a production level when MR = MC
Production & fixed costs in the short run
changes to fixed costs do not affect a firm’s marginal cost of production
As long as min AVC < P, then a firm should continue to produce at the quantity where MR = MC
Production & fixed costs in the long run
if a firm makes a loss it will exit the industry - at an industry level this alters the price that the remaining firms face - eventually they will return to making zero profit
Accounting costs
Actual payment made by a firm in a period
Normal profit
in a competitive industry, the long run firms make zero economic profit i.e. ‘normal’ profit where TC=TR - difference between is 0
Supernormal profit
Profit over & above the return earned at the market rate i.e. above normal profit - a firm might like this but competition can drive this profit down to a normal level - not good in the long term
Equilibrium
Constituted by a price & a quantity (in a free, perfect market) - in particular a price where the market clears - price at which quantity supplied = quantity demanded
The demand curve Qd = 10 - 1Px + 0.5Py
What do the letters stand for & (-) & 10
Px = price of good x
Py = price of substitute good
Qd = the quantity demanded of good x
- = inditaes that as the price of good x goes up the quantity demand of good x goes down
10 = other factors
