Exam 2 Flashcards
What is industrial organization?
the study of how firm’s decisions about prices and quantities depend on the market conditions they face
What is the definition Total Revenue?
the amount a firm receives for the sale of its output
What is the math equation for Total Revenue?
TR = (quantity of output)(price)
What is Total Cost?
TC: the market value of the inputs a firm uses in production
How is Profit calculated?
Profit = Total Revenue - Total Cost
What are Explicit Costs?
input costs that require an outlay of money by the firm
What are Implicit Costs?
input costs that do not require an outlay of money by the firm
What is Economic Profit?
Total Revenue - Total Cost, includes both explicit and implicit costs
What is Accounting Profit?
Total Revenue - Total Explicit Cost
Why is Accounting Profit usually larger than Economic Profit?
Because Accounting Profit ignores implicit costs
What is the Production Function?
the relationship between quantity of inputs used to make a good and the quantity of output of that good
What is Marginal Product?
the increase in output that arises from an additional unit of cost
What is Diminishing marginal product?
the property whereby the marginal product of an input declines as the quantity of the input increases
What are Fixed Costs?
FC, costs that do not vary with the quantity of output produced
What are Variable Costs?
VC, costs that vary with the quantity of output produced
How are Total Costs calculated with variable and fixed costs?
- Total cost = Fixed costs + variable costs
- TC = FC + VC
What are Average Total Costs and how are they calculated?
- total cost / quantity of output
- ATC = Average Fixed Cost + Average Variable Cost
- ATC = Total Cost / Quantity
What are Average Fixed Costs?
- Fixed Cost / quantity of output
- AFC = FC / Q
What are Average Variable Costs?
- variable cost / quantity of output
- AVC = TC / Q
What is Marginal Cost?
the increase in total cost that arises from an extra unit of production
How is Marginal Cost calculated?
- MC = change in total cost / change in quantity
- MC = ΔTC / ΔQ
What are 3 features of cost curves that are typical of many firms?
1) Marginal cost rises with the quantity of input
2) The average-total-cost curve is U-shaped
3) The marginal-cost-curve crosses the average-total-cost curve at the minimum of average total cost
What is the efficient scale?
- the quantity of output that minimizes average total cost
- bottom of the U on average total cost curve
What is the relationship between Marginal Cost and Average Total Cost?
- If Marginal Cost > Average Total Cost, Average Total Cost is rising
- If Marginal Cost
What is Economies of Scale?
the property whereby long-run average total cost falls as the quantity of output increases
How do Economies of Scale often arise?
Often arise because higher production levels allow specialization of workers
What are Diseconomies of Scale?
the property whereby long-run average total cost rises as the quantity of output increases
How do Diseconomies of Scale often arise?
Often arise because the more stretched the management team becomes, the less effective they are keeping costs down
What is Constant returns to scale?
the property whereby long-run average total cost stays the same as the quantity of output changes
What curve is Marginal Cost the slope of?
the total cost curve
How are fixed costs and marginal costs related?
No relationship
How are marginal cost and marginal product related?
inverse relationship
If Marginal Cost > Average Total cost:
- Average Total Cost is rising
- Average Variable Cost is rising
If Marginal Cost
Average Total Cost declining
If Marginal Cost
Average Variable Cost is declining
If Marginal Cost = Average Total Cost:
Average Total Cost is at minimum
What does Average Fixed Cost always do with an increase in output?
Always declines with an increase in output
What is market power?
if a firm can influence the market price of the good it sells
What is a competitive market?
a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker
What is a price taker?
Buyers and sellers must accept the price determines
What are the 2 main characteristics of a competitive market?
1) There are many buyers and sellers in the market
2) The goods offered by the various sellers are largely the same
What is a 3rd optional but important characteristic of a competitive market?
firms can freely enter or exit a market
What is Average Revenue?
- total revenue / quantity
- Average revenue always equals the price of the good
What is Marginal Revenue and how is it calculated?
- the change in total revenue from an additional unit sold
- MR = ΔTR / ΔQ
When does marginal revenue equal the price of a good?
for competitive firms
What are the 3 rules of profit maximization?
1) If marginal revenue if greater than marginal cost, the firm should increase its output
2) If marginal cost is greater than marginal revenue, the firm should decrease its output
3) At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal
What is a shutdown?
refers to a short-run decision not to produce anything during a specific period of time because of current market conditions
What is an exit?
refers to long-run decision to leave the market
What is the difference between a shutdown and an exit in terms of cost?
- Firm that shuts down temporarily still has to pay its fixed costs
- Firm that exits the market does not have to pay any costs at all
When does a firm shut down in the short term?
- The firm shuts down if the revenue that it would earn from producing is less than its variable costs of production
When does a firm shut down in the short term in terms of math?
Shut down if:
1) TR less than TC
2) TR / Q less than VC / Q
3) P less than AVC
What is a competitive firm’s short-run supply curve?
the portion of its marginal cost curve that lies above average variable cost
What is a sunk cost?
a cost that has already been committed and cannot be recovered
What is a firms long run decision to enter or exit a market?
The firm exits the market if the revenue it would get from producing is less than its total costs
What is a firms long run decision to enter or exit a market in terms of math?
Exit if: 1) TR less than ATC 2) TR / Q less than TC / Q 3) P less than ATC Enter if: 1) P greater than ATC
What is a competitive firm’s long run supply curve?
the portion of its marginal cost curve that lies above average total cost
What is another way to write the Profit equation?
(P - ATC) x Q
In the long-run equilibrium of a competitive market with free entry and exit what must a firm be doing?
operating at their efficient scale
What happens with profit in the zero-profit equilibrium?
economic profit is zero but accounting profit is positive
Why is the long-run supply curve typically more elastic than the short-run supply curve?
Because more firms can enter and exit more easily in the long-run than in the short run
What is the definition of a monopoly?
a firm that is the sole seller of a product without close substitutes
What is the fundamental cause of monopolies?
barriers to entry
What are the 3 main barriers to entry?
1) Monopoly resources : key resource owned by single firm
2) Government regulation: legal right to a monopoly
3) the production process: can produce a good at a lower cost than can a large number of producers
What is a natural monopoly?
a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could 2 or more firms
What is the key difference between a competitive firm and monopolistic firm?
monopoly’s ability to influence the price of its output
What is the output effect in a monopoly?
more output is sold, so Q is higher, which tends to increase total revenue
What is the price effect in a monopoly?
the price falls, so P is lower, which tends to decrease total revenue
What is price discrimination?
the business practice of selling the same good at different prices to different customers
What shape is a monopoly’s demand curve?
downward sloping
How do you maximizing profit in a monopoly on a graph?
choose the quantity at which marginal revenue equals marginal cost. Then use the demand curve to find the price that will induce customers to buy that quantity
How is a monopolist’s profit maximizing quantity of output determined?
The monopolist’s profit maximizing quantity of output is determined by the intersection of the marginal-revenue curve and the marginal-cost curve
How is the price equation of a good affected by a monopoly?
P > MR = MC
What are welfare economics?
the study of how the allocation of resources affects economic well-being
What is willingness to pay?
the max amount that a buyer will pay for a good
What is consumer surplus?
the amount a buyer is willing to pay for a good minus the amount the buyer actually paid for a good
How is consumer surplus measured on a graph?
The area below the demand curve and above the price measures the consumer surplus in the market
What is cost?
the value of everything a seller must give up to produce a good
What is producer surplus?
the amount a seller is paid for a good minus the seller’s cost of providing it
How is producer surplus measured on a graph?
The area below the price and above the supply curve measures the producer surplus in a market
What is Efficiency?
the property of resource allocation of maximizing the total surplus received by all members of society
What is Total Surplus?
1) consumer surplus + producer surplus
2) TS = Value to buyers - Cost to sellers
What is Equality?
the property of distributing economic prosperity uniformly among the members of society
What are 3 insights about market outcomes?
1) Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay
2) Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost
3) Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus
What is the only monopoly in the US?
Paper Collar Industry
What is the market demand curve for a good equal to in a monopoly?
the firm’s average revenue curve
In a monopoly, what should a firm do if Marginal Revenue > Marginal Cost?
expand
In a monopoly, what should a firm do if Marginal Revenue is less than Marginal Cost?
contract
What is the markup price equation?
(marginal cost)(markup) = Price
What is markup equal to in the markup price equation?
Ed/Ed - 1 (Ed = price elasticity)
What are the 2 principles of Markup pricing?
1) the higher the Elasticity, the lower the markup
2) the lower the Elasticity, the higher the markup
What is an oligopoly?
a market structure in which only a few sellers offer similar products or identical products
What is game theory?
the study of how people behave in strategic situations
What is collusion?
an agreement among firms in a market about quantities to produce or prices to charge
What is a cartel?
a group of firms acting in unison
What is a Nash equilibrium?
a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen
How do firms in an oligopoly maximize profit?
they produce a quantity of output greater than the level produced by monopoly and less than the level produced by competition. The oligopoly price is less than the monopoly price but greater than the competitive price (which equals marginal cost)
What happens as more and more sellers enter an oligopoly?
an oligopolistic market looks more and more like a competitive market. The price approaches marginal cost and the quantity produced approaches the socially efficient level
What is prisoner’s dilemma?
a particular “game” between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial
What is dominant strategy?
a strategy that is best for a player in a game regardless of the strategies chosen by the other players
