Economics Flashcards
What are the five main factor for a change in Demand i.e that causes a shift in demand? Elaborate.
Price of related goods : Subs and complements Expected future prices Income Taste/brand loyalty population Elaborate, yourself
What is supply. And what is law of supply…and why? if that makes sense
The quantity supplied is the amount producers PLAN to sell during a given time period for a particular price. The higher the price of the good, the more that will be supplied. WHY? as price increases, higher costs, but it is worth incurring the higher costs through better factories etc.
what is reservation price? What causes a shift in supply? 6 factors.
reservation price is the min price at which suppliers are willing to produce.
Input/production costs
prices of related goods. Subs and complements.
expected future prices
No. of suppliers - competition
technology
state of nature - politics
Explain price elasticity of demand. and what its values mean?
It is change in quantity demand/change in price. BUT change in quantity demanded is change in quantity demanded/Quantity average. Due to fluctuation in price and demand, we take the average.
Ed < 1 = inelastic demand
Ed = 2 = unit elastic demand
Ed > 1 = elastic demand.
What are the factors affecting price elasticity?
What is the cross elasticity of demand?
THe closeness of substitutes, the proportion of income spent on the good e.g. bread vs phone. and time period, as in the preferences of the society at the current time.
It is the measure of the responsiveness of demand of a good in relation to a change in the price in a substitute or a complement ceteris paribus.
What is economic profit? And what is opportunity cost?
It is Total revenue - Total cost. Economists think of total cost as the total opportunity cost. btw Economic profit is NOT EQUAL to the actual profit.
Opportunity cost is the value of the next best alternative given up. Opportunity costs include explicit and implicit .
Explicit = material costs, salary etc
Implicit = the salary given up by CEO, time of entrepreneur, (other uses of the machinery)
What are the two time frames and what are the key characteristic of each time frame?
Short run and Long run. Short run is when at least one input - usually capital is fixed. In the long run, all inputs including plant size is variable.
Define Marginal Output, Average product.
What is the law of diminishing returns?
Where is the minimal cost?
MP is change in total output / change in that variable input. (usually step changes like additional worker).TP is Total product/variable input. Careful, it is divided by variable input, NOT total input.
As a firm increases variable inputs for a constant fixed input, the marginal product eventually falls.
Minimal cost is also when MC = AC.
What causes economies of scale and why diseconomies of scale? There are three reasons for each.
Eco of Scale cuz specialization and division of labour. Multistage production in one big factory - saves transportation costs. Purchasing power increases, discounts.
Diseconomies of scale cuz management inefficiencies, complex interdependence of mass production. Workers alienated due to repititive work. Workers become unionised & more powerful raising wages.
Define perfect competition. How does perfect competition arise? give an eg
and describe the price and quantity graph.
Perfect competition is a hypothetical scenario where all firms produce identical products, perfect substitutes. No Barrier of entry. Many firms. They are all usually price takers and changing the price in the slightest will lose all or most customers. Firm’s Minimum efficient scale us small relative to the market demand. Market demand will always be higher. so, all the firms are price takers cuz individual firms don’t have enough influence to determine the prices. Take price as constant. e.g. flower farmers.
The firm’s quantity supplied is perfectly inelastic cuz they don’t decide the price.
Define marginal Revenue
Change in total revenue/change in output.
in perfect competition, MR = Price. cuz think about it.
What is marginal analysis used for and do it.
Marginal analysis is used to find the profit maximizing output.
Basically Compare the marginal cost of producing one more unit to the Marginal revenue of selling one more product. Use MC = MR rule to find profit maximization point. When drawing the graph, you need to draw MC, MR and ATC. For economic profit, Draw MC. Then draw ATC wayy below. And MR should be a straight line passing above ATC. That difference is the economic profit.
For economic loss do same but MR is below and ATC is way above. (makes sense right?) for break even, try to intersect all three graphs together at one point.
What is imperfect competition ? What factors make it imperfect ? As in what are the barriers for entry into the market. There is 4 of them
1) Economies of scale ( need I say more )
2) Product differentiation and brand loyalty. Connected to advertising.
3) Legal barriers to entry - Monopoly franchise, government interventions, patents ( software, pharmaceuticals)
4) Control of resources.
What are some pros and cons of monopolies.
Cons :
1) Excessive profit seeking - they also spend huge amounts of money to keep it a monopoly thru political lobbying etc.
2) underproduction or high inefficiencies.
Pros :
1) +ve economics profit in the long run. Inverted to R&D and innovation. They have incentive to innovate because patents run out.
2) economies of scale, cheaper more affordable goods.
talk about short run and long run equilibrium for monopolistic competition.
Short run - Price > average cost. firms can make +ve economic profit.
Long run - Firms can enter easily so supernormal profits will attract attention and firms will come in. so, reduced market share, and entry continues until profit becomes normal i.e. demand curve touches ATC. - Price = AC.
Compared with long run, the AC is higher, because they are not producing at optimal levels. And since AC = Price, the price is also higher.
So, firms produce below capacity.
What is an oligopoly, what are the implications?
An oligopoly is when there are a few number of firms, products may be differentiated, restricted entry - various reasons. They tend to work together.
the implications are that the decisions of individual firms can/will affect the decision of other firms. (wait a min, why didnt we talk about this in monopolistic competition? simply cuz there are too many firms in monopolistic competition).
Oligopolies can make strategic inter dependencies.
what is the difference between collusive and non-collusive oligopolies.
What is a cartel.
Collusive oligopolies cooperate in terms of deciding the production qouta or the price. If they set production volume, the market sets the price. MR = MC on graph = quantity. MC = Demand curve = price. ( see graph in notes.
Cartel is formed when companies enter a formal agreement regarding production qouta/price. Its illegal btw. but hidden collusions usually happen. And even if there are collusion companies tend to cheat. It happens because it is illegal anyway and if something happens, they can’t take each other to court anyway.
What is a kinked demand curve? What is game theory. The explanation in notes is just an explanation of game theory but in the firms taking decisions context. Understand game theory and you should be able to replicate a situation for companies urself.
What happens to the solution matrices if decisions are taken simultaneously or after one other.
it is how companies predict what will happen if companies cheat at a hidden collusion. see graph to see how it works. A better framework is game theory. cuz it doesn’t mention about initial price. Use a outcome matrix to figure out what happens for each scenario where each company cheats. See notes for exhaustive explanation.
What happens to the outcomes of collusion in the long run ?
In the long run, companies might not want to cheat to retain trust so that they both can get the best deal possible. In the short run it might be more beneficial to cheat.
What are the different souces of investment for a firm and what are their respective costs? - There are both long term and short terms btw.
In reality which source/sources do firms take from?
In the longer term - there is Retained Earnings, Loan Capital and Issued shares.
Retained earnings is just Total profits - (Total tax + total dividends). There is no implicit costs incurred to this apart from the opportunity cost.
Loan Capital. Corporate bonds or government bonds. repayable after a fixed period of time with an additional interest. - there is some certainty of getting repaid from this.
Equity Capital. Ordinary shares are traded on the stock market. Dividends need to paid back IF there is a profit made so there is a degree of uncertainty to it. Hence, there is a risk premium.
In reality, firms usually take a mixture of all of these are the percentage is calculated as a weighted average.
What is the importance of time in retaining money for a firm? As in why better to take money now than in the future? Connect to concept of discounting. What is discounting? And do you know the formula for calculating the present value?
Element of uncertainty involved in not taking money now. AND The value might depreciate.
Discounting is conversion of a future value into present value. - due to inflation whatnot. See handouts for formulas.
What is Net Present Value? What does it tell?
A positive net present value tells that the future anticipated earnings of a business exceed the future anticipated costs of a business. It takes into account time and not simply the numbers. If it is equal to zero, break-even might occur and if it is negative, the project is likely to incur more costs and economic loss is likely to occur. It is a good way to decide if a project is worth investing in. The formula is in the handout. -
What is IRR? WHat does it tell? How should a firm decide whether to invest or not. How is the number comparable to NPV?
It is the discount rate for which a firm will make NPV = 0 for a particular project for a particular time period. Formula is same as NPV but use trial and error, it is easier. Usually, the higher the IRR the safer a firm is to invest in. If IRR > opportunity cost of capital = NPV > 0 INVEST !
if IRR < opportunity cost of capital = NPV < 0 = DO NOT INVEST !
Comparing between NPV and IRR - are they really the same?
Advantages of NPV - it takes into account the size of the business. e.g. a big project yielding a 10% profit may give more than a small project giving a 20%. Example in handout clearly portrays this. Project A has IRR value of 19.2 % and Project B 27.3%. However, NPV is higher at discount rates of 10% for Project A than Project B.
