Handout 6 Flashcards
What are opportunity costs? How do explicit and implicit costs relate to opportunity costs?
The opportunity cost of an item refers to all those things that must be forgone to acquire that item. Both explicit and implicit costs are included as opportunity costs.
A key difference between accountants and economists is their different treatment of the cost of capital. Does this cause an accountant’s estimate of total costs to be higher or lower than an economist’s estimate? Explain.
An accountant would not include the forgone interest income that the money could have earned elsewhere if it had not been invested in the business. Therefore, an accountant’s estimate of total cost will be less than an economist’s.
The production function depicts a relationship between which two variables? Also, draw a production function that exhibits diminishing marginal product.
The production function depicts the relationship between output and a given input. The graph below shows output increasing but at a decreasing rate as the quantity of inputs increases.
How would a production function that exhibits decreasing marginal product affect the shape of the total cost curve? Explain or draw a graph.
The total cost curve will increase at an increasing rate, or in other words, the total cost curve gets steeper as the amount produced rises.
What effect, if any, does diminishing marginal product have on the shape of the marginal cost curve?
Diminishing marginal product causes the marginal cost curve to rise.
If the average total cost curve is falling, what is necessarily true of the marginal cost curve? If the average total cost curve is rising, what is necessarily true of the marginal cost curve?
When average total cost curve is falling, marginal cost is below ATC. If the average total cost curve is rising, marginal cost is above ATC.
List and describe the characteristics of a perfectly competitive market.
There are many buyers and sellers in the market. The goods offered by the various sellers are largely the same. Firms can freely enter or exit the market.
Why would a firm in a perfectly competitive market always choose to set its price equal to the current market price? If a firm set its price below the current market price, what effect would this have on the market?
The firm could not sell any more of its product at a lower price than it could sell at the market price. As a result, it would needlessly forgo revenue if it set a price below the market price. If the firm set a higher price, it would not sell anything at all because a competitive market has many sellers who would supply the product at the market price.
Use a graph to demonstrate the circumstances that would prevail in a competitive market where firms are earning economic profits. Can this scenario be maintained in the long run? Explain your answer.
In a competitive market where firms are earning economic profits, new firms will have an incentive to enter the market. This entry will expand the number of firms, increase the quantity of the good supplied, and drive down prices and profits. Entry will cease once firms are producing the output level where price equals the minimum of the average total cost curve, meaning that each firm earns zero economic profits in the long run.
Explain how a firm in a competitive market identifies the profit-maximizing level of production. When should the firm raise production, and when should the firm lower production?
The firm selects the level of output at which marginal revenue is equal to marginal cost. If MR > MC, profit will increase if the firm increases Q. If MR < MC, profit will increase if the firm decreases Q.
