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ICAS > Economic Primer: Basic Principles > Flashcards

Economic Primer: Basic Principles Flashcards

1
Q

Cost function

A

Profit = Revenue - Costs

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2
Q

Total cost function

A

relationship between a firm’s total costs and the amount of output it produces in a given time period, assuming that the firm produces in the most efficient manner possible given its current technological capabilities

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3
Q

average cost function, AC(Q)

A

how the firm’s average/per-unit-of-output costs vary within the amount of output it produces

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4
Q

economies of scale

A

average cost decreases as output increases

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5
Q

diseconomies of scale

A

average cost increases as output increases

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6
Q

constant returns to scale

A

average cost remains unchanged with respect to output

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7
Q

minimum efficient scale (MES)

A

the smallest level of output at which economies of scale are exhausted

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8
Q

marginal cost function, MC(Q)

A

the rate of change of total cost with respect to output or thought of as the incremental cost of producing exactly one more unit of output

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9
Q

marginal cost often depends on …

A

marginal cost often depends on the total volume of output

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10
Q

at low levels of output (Q’), increasing output by one unit does …

A

at low levels of output, increasing output by one unit does not change total costs much as reflected by the low MC

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11
Q

at higher levels of output (Q’’), a one-unit increase in output has …

A

at higher levels of output (Q’’), a one-unit increase in output has a greater impact on total costs, corresponding MC is higher

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12
Q

If AC is a decreasing function of output

A

MC < AC

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13
Q

If AC neither increases/ decreases in output, because it is either constant (independent of output) or at a minimum point

A

MC = AC

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14
Q

If AC is an increasing function of output

A

MC > AC

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15
Q

Short run is the period in which …

A

Short run is the period in which the firm cannot adjust the size of its production facilities

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16
Q

SAC

A

short-run average cost

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17
Q

short-run average cost function

A

annual variable inputs (labor, materials) as well as the FC (e.g., plant)

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18
Q

Sunk costs

A

unavoidable costs that must be incurred no matter what the decision is

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19
Q

avoidable costs

A

costs that can be avoided if certain choices are made

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20
Q

when weighing the costs of a decision, the decision maker should …

A

when weighing the costs of a decision, the decision maker should ignore sunk costs and consider only avoidable costs

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21
Q

whether a cost is sunk depends on …

A

whether a cost is sunk depends on the decision being made and the options at hand

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22
Q

Sunk costs = fixed costs?

A

Sunk costs ≠ fixed costs: all sunk costs are fixed but not all fixed costs are sunk

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23
Q

opportunity costs

A

the economic cost of deploying resources in a particular activity is the value of the best foregone alternative use of those resources

24
Q

accounting profit

A

sales revenue - accounting cost

Accounting profit is the net income for a company, which is revenue - expenses

25
Q

economic profit

A

sales revenue - economic cost = accounting profit - (economic cost - accounting cost)

Similar to accounting profit but includes opportunity costs

26
Q

demand function

A

the relationship between the quantity of a product the firm is able to sell and all the variables that influence that quantity

27
Q

law of demand

A

inverse relationship (of demand function); may not hold if high prices corner prestige or enhance the product’s image

28
Q

price elasticity of demand

A

measures the sensitivity of quantity demanded to price

29
Q

price elasticity < 1

A

demand is inelastic

30
Q

price elasticity > 1

A

demand is elastic

31
Q

factors that tend to make demand for a firm’s product more sensitive to price (more elastic)

A
  • product has unique features that differentiate it from rival products
  • buyers’ expenditures on the product are a large fraction of their total expenditures, where savings from finding a comparable item at a lower price is large
  • the product is an input that buyers use to produce a final good whose demand itself is sensitive to price
32
Q

factors that tend to make demand less sensitive to price (more inelastic)

A
  • comparisons among substitute products are difficult (complex, no experience, costly, …)
  • because of tax deduction/insurance, buyers pay only a fraction of the full price of the product (e.g., health insurance)
  • high switching costs (e.g., arises when product requires specialized training)
  • product is used in conjunction with another product that buyers have committed themselves to (printer & toners)
33
Q

total revenue function, TR(Q)

A

indicates how the firm’s sales revenues vary as a function of how much product it sells

34
Q

marginal revenue, MR(Q)

A

the rate of change in total revenue that results from the sales of ΔQ additional units of output

35
Q

revenue destruction effect

A

to sell more, a firm must lower its price. thus, while it generates revenue on the extra units of output it sells at the lower price, it loses revenue on all the units it would have sold at the higher price

36
Q

positive marginal revenue (depending on price elasticity of demand)

A

demand is elastic > 1 –> MR > 0 –> increase in output brought about by a reduction in price will total sales revenues

37
Q

negative marginal revenue (depending on price elasticity of demand)

A

demand is inelastic < 1 –> MR < 0 –> increase brought about by a reduction in price will lower total sales revenue

38
Q

MR < P

A

the marginal revenue curve must lie everywhere below the demand curve, except at a quantity of 0

39
Q

theory of the firm

A

assumes that the firm’s ultimate objective is to make profit as large as possible

  • how prices are established in markets provides tools to aid managers in pricing decisions
40
Q

a firm would likely increase profit if …

A
  • if MR > MC, the firm can increase profit by selling more (ΔQ > 0) by lowering prices
  • If MR < MC, the firm can increase profit by selling less (ΔQ < 0) by raising prices
  • If MR = MC, the firm cannot increase profits by increasing/decreasing Q. Output and price must be at their optimal levels
41
Q

Express MR in terms of the price elasticity of demand

A

VC are directly proportional to output, so that MC = AVC

42
Q

PCM

A

percentage contribution margin

43
Q

percentage contribution margin

A

the percentage contribution margin on additional units sold is the ratio of profit per unit to revenue per unit

44
Q

the lower a firm’s PCM (e.g., because MCs are high) …

A

… the greater its price elasticity of demand must be for a price-cutting strategy to raise profits

45
Q

If MR - MC > 0 as n > 1/PCM …

A

if MR - MC > 0 as n > 1/PCM: A firm should lower its price whenever the price elasticity of demand is less than the reciprocal of the PCM on the additional units it would sell by lowering its price

46
Q

if MR - MC < 0 as n < 1/PCM …

A

if MR - MC < 0 as n < 1/PCM: A firm should raise its price when the price elasticity of demand is less than the reciprocal of the PCM of the additional units it would not sell by raising its price

47
Q

perfect competition

A

a stark competitive environment: an industry with many firms producing identical products and where firms can enter or exit the industry at will

48
Q

industry-level price elasticity of demand

A

the industry-level price elasticity of demand facing a perfect competitor is infinite, even though the industry-level price elasticity is finite

49
Q

marginal supply curve

A

how a firm’s optimal output changes as the market price changes, the supply curve for a perfect competitive firm is identical to its marginal cost function

50
Q

industry supply curve (SS)

A

aggregate of the firm supply curves of all active producers in the industry

51
Q

game theory

A

the analysis of optimal decision making when all decision makers are presumed to be rational, and each is attempting to anticipate the actions and reactions of its competitors

52
Q

Nash equilibrium

A

each player is doing the best it can, given the strategies of other players

53
Q

dominant strategy

A

when a player has a dominant strategy, it follows that the strategy must also be the player’s Nash equilibrium strategy. they are not inevitable.

54
Q

prisoner’s dilemma

A

conflict between collective interest and self-interest

55
Q

subgame perfect Nash equilibrium (SPNE)

A

each player chooses an optimal action at each stage in the game that it might conceivably reach and believes that all other players will behave in the same way

ICAS (13 decks)

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