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Foundations of Microeconomics > Final exam flashcards > Flashcards

Final exam flashcards

1
Q

What are the four economic principles?

A

Scarcity
Trade-off
Opportunity cost
Incentives.

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2
Q

What are normative statements?

A

Statements that describe how the world SHOULD be

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3
Q

What are positive statements?

A

Statements that describe how the world is.

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4
Q

What are the two types of cost?

A

Implicit and explicit

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5
Q

What are implicit costs?

A

The opportunity cost equal to what a firm must give up in order to use a factor of production for which it already owns.G

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6
Q

Give an example of implicit cost

A

A university does not rent out their facility for summer programs, and therefore incurs an implicit cost.

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7
Q

What are explicit costs?

A

Those that require an outlay of money.

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8
Q

Give an example of an explicit cost

A

Cost of books to study

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9
Q

What is economic profit?

A

Economic profit takes into account both implicit and explicit costs

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10
Q

What is accounting profit?

A

Accounting profit only takes into account explicit costs

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11
Q

What is the formula for accounting profit?

A

Revenue - explicit costs

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12
Q

What is the formula for economic profit?

A

Revenue - explicit cost - implicit cost

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13
Q

What are marginal costs?

A

Marginal costs are those incurred by increasing the production of a good or service by one unit.

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14
Q

What are the three types of marginal costs?

A

Increasing, decreasing, constant

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15
Q

What is the optimal quantity of production?

A

The optimal quantity of production is the quantity that generates the highest possible total profit.

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16
Q

Where is the optimal quantity of production for consumers?

A

For consumers, the optimal quantity of production occurs when the marginal cost and the marginal benefit intersect.

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17
Q

Where is the optimal quantity of production for producers?

A

For producers, the optimal quantity of production occurs when the marginal cost and marginal revenue intersect.

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18
Q

What is marginal benefit?

A

Marginal benefit is the additional benefit derived from producing one more unit of a good/service.

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19
Q

What is the marginal benefit curve?

A

The marginal benefit curve shows how the benefit from producing one more unit depends on the quantity that has already been produced.

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20
Q

What is the profit-maximising principle of marginal analysis?

A

The largest quantity at which marginal benefit is greater than or equal to marginal cost.

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21
Q

What is a rational decision?

A

A rational decision always chooses the variable option that leads to the outcome he or she most proferes.

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22
Q

What are the 3 reasons why people might rationally choose a worse payoff?

A

Concerns about fairness
Bounded rationality
Risk aversion

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23
Q

What is an example of “concerns about fairness”

A

Donating to the local food bank each year, an action that reduces their personal financial benefit

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24
Q

What is bounded rationality?

A

Bounded rationality (“good enough”) describes a situation where rational people may settle for “good enough” choices when finding the best payoff is too costly or difficult.

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25
Q

What is an example of bounded rationality?

A

Travelling to Madrid to Segovia for a marginally cheaper laptop

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26
Q

What is risk aversion?

A

Risk aversion describes the tendency to accept lower returns to avoid potential loss

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27
Q

Give an example of risk aversion?

A

An investor opts for a low-interest savings account rather than a higher-risk stock market investment to avoid potential losses.

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28
Q

What is utility?

A

Utility is a measure of the satisfaction or happiness a person derives from consuming goods, services, or making decisions

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29
Q

What is marginal utility?

A

Marginal utility is the additional satisfaction or happiness gained from consuming one more unit of a good or service.

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30
Q

What type of function is utility?

A

Utility is a parabolic function.

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31
Q

How is marginal utility per dollar found?

A

The MU per dollar is found by dividing the MU by the price of the good.

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32
Q

What are the three measures that constitute utility?

A

The utility function.
The consumption bundle.
The optimal consumption bundle.

33
Q

What is the utility function?

A

The utility function is a way to measure how much satisfaction or happiness a person gets from different combinations of goods or services.

34
Q

What is the consumption bundle?

A

The consumption bundle is a set of goods and services a person chooses to consume, which determines their overall satisfaction or happiness.

35
Q

What is the optimal consumption bundle?

A

The optimal consumption bundle is the “perfect” consumption of goods/services that maximises utility (satisfaction).

36
Q

What is perfect competitve?

A

A theoretical market structure with many firms, each with a very small market share, selling identical products.

37
Q

What are the three assumptions behind perfect competition?

A

Perfect information.
No barriers to entry.
Firms and consumers are price takers.

38
Q

Provide 2 examples of perfect competition

A

Agricultural and financial markets

39
Q

What are the 5 characteristics of perfect competition?

A

Many small firms.
Identical products.
Perfect information.
Free entry and exit.
Perfect elasticity of demand.

40
Q

How does marginal/average revenue work with perfect competition?

A

In perfect competition, MR/AR is equal to the market price because each unit sold generates the same revenue.

41
Q

In perfect competition, where do firms maximise profits?

A

Firms maximise profits where marginal revenue (MR) equals marginal cost (MC), which is the profit-maximising output level.

42
Q

In perfect competition, what happens if TR > TC

A

If TR > TC, the firm earns economic profit in the short run.

43
Q

In perfect competition, what happens if TR = TC

A

When TR=TC, the firm breaks even.

44
Q

In perfect competition, what happens if TR < TC

A

If TR < TC, the firm incurs a loss.

45
Q

Describe the mechanism of perfectly competitive markets in terms of economic profit

A

A higher price will attract new firms, increasing supply and reducing price in the long run.

Conversely, a price drop may cause firms to exit, reducing supply and raising the price back to equilibrium (zero economic profit)

46
Q

In perfect competition, what is productive efficiency and when does it occur?

A

Productive efficiency is achieved when firms produce at the lowest possible cost, which is where the AC = MC.

47
Q

In perfect competition, what is allocative efficiency and when does it occur?

A

Allocative efficiency occurs when resources are allocated to produce the quantity of goods most desired by society, where MSB = MSC.

48
Q

In perfect competition, why would a firm want to enter an industry if the market price is only slightly above the break-even price (minimum average total cost, ATC)?

A

If the market price is just slightly above the break-even level (covering all costs), the firm can still earn more in this industry than it could elsewhere.

Even a small economic profit signals that this industry is better than other opportunities, encouraging firms to enter as long as there’s any positive economic profit.

49
Q

In perfect competition, why would a firm continue operating at a loss in the short run instead of shutting down?

A

In the short run, firms may keep producing even if they incur losses, as long as they can cover their variable costs (e.g., materials and labour) and contribute something toward their fixed costs (e.g., rent or equipment).

50
Q

At what point in perfect competition will a firm exit the market?

A

The firm will shut down only if the market price falls below the shutdown price, which is the minimum point of the average variable cost (AVC) curve. At this point, the revenue from sales doesn’t even cover the variable costs, so it’s better to stop production to avoid further losses.

51
Q

What is the desirable characteristic of perfect competition?

A

Perfectly competitive markets theoretically lead to optimal resource allocation and cost minimization.

52
Q

What is the undesirable characteristic of perfect competition?

A

It is not a real market structure. Real-world markets rarely meet all criteria for perfect competition, as true identical products and perfect information are uncommon.

53
Q

What is a monopoly?

A

A monopoly exists when a single producer (monopolist) controls the entire market for a good or service with no close substitutes.

54
Q

How does a monopolist exploit their market power in terms of pricing?

A

The monopolist can raise prices above marginal cost without losing all customers, a luxury unavailable in competitive markets.

A monopolist reduces the quantity supplied to a level where marginal revenue (MR) equals marginal cost (MC), thus maximising profit.

55
Q

What is the main characteristic of a monopoly?

A

High barriers to entry

56
Q

What are the types of barriers to entry in a monopoly?

A

Control of scarce resources.

Increasing returns to scale (benefiting off economies of scale).

Technological superiority.

Network externalities (self-reinforcing demand)

Government-created barriers (patents, copyrights).

57
Q

Where to monopolies set their output level?

A

Monopolies set output level at the profit-maximising level of output:

Output is chosen where MR = MC (MR = ΔTR/ΔQ)

Price is set based on the demand curve at that output level.

58
Q

What is price discrimination?

A

Price discrimination occurs when companies charge different prices for the same good to different consumers, based on their willingness to pay.

59
Q

What are the three types of price discrimination?

A

Advanced purchase restrictions

Volume discounts

Two-part tariffs

60
Q

What is perfect price discrimination?

A

Perfect price discrimination involves charging each consumer their maximum willingness to pay.

61
Q

What are the challenges faced by monopolies?

A

Monopolies face efficiency challenges because they prioritise profits over social welfare, creating inefficiencies.

62
Q

What is monopolistic competition?

A

Monopolistic competition is a market structure that combines features of monopolies and perfect competition.

It is the most realistic market structure, and is seen in many industries.

63
Q

What are the characteristics of monopolistic competition?

A

Many competitors

Product differentiation

Free entry and exit

64
Q

What is a real life example of monopolistic competition and why?

A

A real-world example of monopolistic competition is the restaurant industry.

While all restaurants offer food services, they differentiate through their menus, dining experiences, and even location.

This allows them to compete while maintaining some pricing power.

65
Q

What are the three ways firms differentiate in monopolistic competition?

A

Differentiation by style/type, where firms target different consumer preferences.

Differentiation by location, where a key differentiating factor is convenience.

Differentiation by quality, where firms cater to distinct consumer bases.

66
Q

What are the industry dynamics of market competition?

A

New firms entering the market intensify competition.
A wider range of products benefits consumers, as they can choose items that best match their preferences.

While this diversity may lead to higher costs, it increases overall satisfaction.

67
Q

What traits make monopolistic competition inefficient?

A

Excess capacity, since firms produce at a quantity less than their ATC. They can produce more, but they won’t because that would require lowering prices.

Prices are above marginal cost.

The inefficiency is counterbalanced by the increased product variety available to consumers.

68
Q

What two purposes does advertising serve in monopolistic competition?

A

Even without providing factual information, advertising can make products more desirable through branding.

Advertising can also be “informative,” offering details about product prices, quality, or availability. This form of advertising helps consumers make more informed decisions and reduces search costs.

69
Q

What is an oligopoly?

A

An oligopoly is a market dominated by a small number of firms.

70
Q

Where do oligopolies occur?

A

Oligopolies occur in markets where there are:

High barriers to entry.

Significant economies of scale.

Limited resources or patent protections.

71
Q

How is market power measured?

A

Economists use the HHI to measure market concentration and identify the extent of competition in an industry.

72
Q

What is the HHI formula?

A

HHI = Sum of the square’s of all firms market shares.

73
Q

What is the meaning of HHI values?

A

If the HHI < 1000, then the market is highly competitive.

If the HHI is between 1000 and 1800, the market is moderately concentrated.

If the HHI is above 1800, the market is an oligopoly.

74
Q

What two choices to firms operating in an oligopoly face?

A

Oligopolistic firms face a choice between competition and collusion to maximise profits.

75
Q

What is collusion?

A

Collusion occurs when firms cooperate to limit output and maintain high prices.

It is often illegal, as a higher degree of market power results in welfare losses.

76
Q

What two types of collusion are there? Provide examples

A

Explicit collusion occurs when there is a formal agreement, such in the case of the OPEC cartel.

Tacit collusion occurs when there are unspoken agreements to avoid price competition.

77
Q

Why do firms in collusion have an incentive to cheat, and how does this lead to a Nash equilibrium?

A

While collusion (cooperation) can lead to higher joint profits, each firm has an incentive to cheat for individual gain.

In many cases, firms act in their own self-interest, leading to a Nash equilibrium, where no firm can improve its payoff by unilaterally changing its strategy.

78
Q

What strategies might firms use to avoid price wars and maintain stability without engaging in overt collusion?

A

Even with thresholds in place to avoid high degrees of collusion, firms may still engage in behaviours such as:
Product differentiation, which involves convincing consumers of unique product value to avoid price wars.

Price leadership, where one firm sets a benchmark price and others follow.

Foundations of Microeconomics (1 decks)

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