Intro: Economics Primer (pages 9-37)

Question 1

What is the law of demand

Answer 1

all other things constant, the lower the price of a product, the more of it consumers will purchase. The lower the price, the higher the demand and vice versa

Question 2

What is price elasticity

Answer 2

cutting the price of a good in response to a competitor’s price cut.

Question 3

Price elastic demand usually implies what as it relates to a price cut?

Answer 3

Not only into higher unit sales, but also higher sales revenue

Question 4

What does a firm’s profit equal?

Answer 4

Revenue minus costs

Question 5

What is the total cost function?

Answer 5

The relationship between a firm’s total cost (TC) and the total output it produces in a given time period (Q)

Question 6

Total cost function reflects what?

Answer 6

Total current capabilities of the firm (and is an efficiency relationship)

Question 7

The total cost function must slope upward – why?

Answer 7

The only way to achieve more output is to use more factors of production, which will raise total costs

Question 8

Why is the lines dividing fixed and variable costs fuzzy?

Answer 8

Some costs, such as maintenance or advertising and promotional expenses, may have both
fixed and variable components. Other costs may be semifixed: fixed over certain
ranges of output but variable over other ranges

Question 9

What does it mean when we say a cost is fixed?

Answer 9

It is invariant to the firm’s output. That’s not to say it can’t be affected by other dimensions of the firm’s operations or related decisions.

Question 10

Whether costs are fixed or variables depends on what?

Answer 10

The time period in which decisions regarding output are contemplated. Whether the firm has the freedom to alter its physical capital or other elements of its operation has important implications for cost structure and nature of its decision making

Question 11

What is the average cost function aka AC(Q)

Answer 11

describes how the firm’s average or per-unit-of-output costs vary with the amount of output it produces.
AC(Q) = TC(Q)/Q

Question 12

Often, average cost will vary with what?

Answer 12

output

Question 13

What are economies of scale?

Answer 13

When average cost decreases as output increases.

Question 14

What are diseconomies of scale?

Answer 14

When average cost increases as output increases.

Question 15

What is a constant return to scale?

Answer 15

When average cost remains unchanged with respect to output

Question 16

Describe minimum efficient scale?

Answer 16

The smallest level of output at which economies of scale are exhausted

Question 17

Describe marginal cost

Answer 17

Refers to the rate of change of total cost with respect to output. Marginal cost may be thought of as the incremental cost of producing exactly one more unit of output.

Question 18

When are average cost and marginal cost similar?

Answer 18

When total costs vary in direct proportion to output

Question 19

When does the total cost function get steeper?

Answer 19

When Q gets larger, and the marginal cost curve must increase in output.

Question 20

When average cost is a decreasing function of output…?

Answer 20

Marginal cost is less than average cost

Question 21

When average cost neither increases not decreases in output…?

Answer 21

Marginal cost is equal to average cost

Question 22

When average cost is an increasing function of output…?

Answer 22

marginal cost is greater

than average cost.

Question 23

Describe a short run?

Answer 23

The period of time in which the firm cannot adjust the size of its production facilities is known as the short run.

Question 24

Describe short run average cost function (SAC)?

Answer 24

Includes the annual costs of all relevant variable inputs and the fixed cost of the plant itself.

Question 25

If a firm knows how much output it plans to produce before building a plant - what should it do to minimize costs?

Answer 25

It should choose a plant size that results in the lowest short-run average cost for that desired output level.

Question 26

What does long run average cost function exhibit in relation to varying plant sizes?

Answer 26

Economies of scale - by operating larger plant sizes, the firm can lower average costs. To realize the lower average costs, the firm must not only build a large plant but must also achieve sufficient output, so
that the large plant is indeed the optimal one

Question 27

Essentially, firms cannot fully exploit economies of scale unless they have…?

Answer 27

Sufficient inputs for production and distribution to get their products to market. Without such throughput,
strategies that hinge on scale economies are doomed to fail.

Question 28

What trend tends to pull down SAC?

Answer 28

as the volume of output increases, average fixed costs become smaller

Question 29

What can pull SAC up?

Answer 29

Offsetting fixed costs that are spread over an ever larger production volume.

Question 30

Define sunk costs

Answer 30

Costs that cannot be avoided no matter the decision

Question 31

Define avoidable costs

Answer 31

Costs than can be incurred or avoided as a result of a decision

Question 32

What defines economic profit?

Answer 32

Sales revenue minus economic cost

Question 33

What does the demand curve describe?

Answer 33

The quantity of product that the firm is able to sell and all the variables that influence the quantity (price of product, price of related products, incomes and tastes of consumers)

Question 34

When would the law of demand not hold?

Answer 34

If high prices confer prestige or enhance a product’s image, or when consumers can’t objectively assess quality

Question 35

Define the reverse destruction effect

Answer 35

While a firm will generate revenue on extra units of outputs it sells at a lower price, it loses revenue on all the units it would have sold at a higher price

Question 36

In general, whether marginal revenue is positive or negative depends on…?

Answer 36

price

elasticity of demand

Question 37

a perfectly competitive firm’s demand curve is

perfectly…?

Answer 37

horizontal at the market price, even though the industry demand curve is
downward sloping. Put another way, the firm-level price elasticity of demand facing a
perfect competitor is infinite, even though the industry-level price elasticity is finite.