Exam 2 Flashcards
Consumer’s optimal choice definition
- tangent of the constraint and indifference curve
- find the pt on the budget constraint that is on the highest indifference curve
consumer’s optimal choice equation
MRSxy=Px/Py
marginal rate of substitution = price ratio
price ratio
Px/Py
how many units of ‘y’ HAVE to give up to get one more unit of ‘x’
marginal rate of substitution
MUx/MUy
-how many units of ‘y’ WILLING to give up for one more unit of ‘x’
if MRS>price ratio, then
level of utility rises
an increase in income (for normal goods) causes
- the budget constraint to shift to the right parallel
- new optimal is made
income consumption curve
-connection of all the optimal points
Engel curve
- quantity v income
- if pos slope- normal good
- if neg slope-inferior good
change in price effect on the budget constraint
curve rotates out off the y-intercept
total effect
=substitution effect+income effect
substitution effect
-as prices rise, buy more of the relatively cheaper goods
income effect
-change in consumers’ consumption choices that result from a change in purchasing power of income
to extract substitution effect
- take new budget constraint and shift in parallel until it’s tangent to the old indifference curve
- new point is A’
- the difference in Q between A and A’ is the substitution effect
to extract the income effect
- take new budget constraint and shift in parallel until it’s tangent to the old indifference curve
- new point is A’
- the difference in Q between B and A’ is the substitution effect
law of demand 2 reasons why
- as price decreases the Qd increases
1. the good gets relatively cheaper than substitutes (buy more)
2. the real income increases
the income effect (inferior goods)
will be neg.
Giffen good
- violates the law of demand
- has a positive slope demand curve
production function
Q=f(K,L)
Q-KaLb
variable input
Q can be changed over a relatively short period of time
fixed input
Q can’t be changed over time
long run
period of time that is long enough that all inputs can be variable
short run
period of time where at least one input is fixed
Increasing the amt of labor…
- can take advantage of specialization and division of labor
- increasing returns
diminishing returns
- as keep adding labor the output increases by smaller and smaller amts, eventually going negative
- starts when marginal product goes down
average product of labor=
total output/#workers
marginal product of labor
increase of output for hiring one more worker
MPL>APL then APL
rises
cause producing more than the average
MPL<APL then APL
falls
cause producing less than the average
isoquants
series of lines that show all combinations of inputs that produce the same level of output
marginal rate of technical substitution=
=ΔK/ΔL
ALSO the slope of the isoquant
-the rate at which one input can be substituted for another without altering the total level of output
-WILLING
optimal input combination
MPL/MPK=w/r
w/r
have to
price ratio
opportunity costs
economic costs; what you give up when you make a decision
accounting costs
something that involves an outlay of money
total economic costs
=opp costs+acct. costs
economic profit
TR-economic costs
accounting profits
=TR-accting costs
sunk costs
costs that once paid cannot be recovered
sunk cost fallacy
- the mistake that you make when you let sunk costs affect future decisions
- everyone does it sometimes…rational behavior
perfect competition
many firms; identical products; no barriers to entry
typical firm in perfect competition
- horizontal demand curve
- price taker
- no impact on the market price
- perfectly elastic demand
- if charged above market price, then sales go to 0 immediately
marginal revenue
increase in TR from selling one more unit
if MR>MC
produce
when MR=MC in perfect competition
stop producing because at profit maximization
short run supply curve
the portion of the MC curve that lies above the AVC curve
if P>ATC then
firms make a profit
short run firm will produce at a loss as long as,
producing reduces the size of the loss
long run equilibrium
MC=ATC (low point)
when more firms enter the industry:
-supply increases
-no profits-no more entry
-P=ATC
still make accounting profit not economic
normal profit
making money but no more than @ next best alternative (no economic profit)
firm working at a loss in the long run
can’t do it
-exit industry cause of repeated losses
as long as P>AVC
the firm should produce in the short run
when P<AVC
the firm should shut down in the short run
minimum of the AVC curve
the shut down point
If P<ATC then firms will
leave the industry in the long run
Constant cost industry
- total costs do not change with total industry output
- long run supply curve horizontal
- demand goes up, profit increases, more firms enter the industry, goes back to original price level
Increasing cost industry
- total costs increase with increases in industry output
- positive sloping long run supply curve
- demand goes up, price goes up, more firms enter, production costs go up, price level ends up being higher than the originial
decreasing cost industry
- total costs decrease with increases in industry output
- neg. sloping long run supply curve
- demand goes up, price goes up, more enter, production costs go down, price levels lower than original
Does price change more in the long run or the short run?
-the short run b/c the LRE stays the same and the short run price falls
Does industry wide Q change more in the short run or the long run?
- the long run b/c more firms exit the market cause P go down
- demand and supply change making it more significant
