Intro: Economics Primer (pages 9-37) Flashcards
What is the law of demand
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
What is price elasticity
cutting the price of a good in response to a competitor’s price cut.
Price elastic demand usually implies what as it relates to a price cut?
Not only into higher unit sales, but also higher sales revenue
What does a firm’s profit equal?
Revenue minus costs
What is the total cost function?
The relationship between a firm’s total cost (TC) and the total output it produces in a given time period (Q)
Total cost function reflects what?
Total current capabilities of the firm (and is an efficiency relationship)
The total cost function must slope upward – why?
The only way to achieve more output is to use more factors of production, which will raise total costs
Why is the lines dividing fixed and variable costs fuzzy?
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
What does it mean when we say a cost is fixed?
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.
Whether costs are fixed or variables depends on what?
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
What is the average cost function aka AC(Q)
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
Often, average cost will vary with what?
output
What are economies of scale?
When average cost decreases as output increases.
What are diseconomies of scale?
When average cost increases as output increases.
What is a constant return to scale?
When average cost remains unchanged with respect to output
Describe minimum efficient scale?
The smallest level of output at which economies of scale are exhausted
Describe marginal cost
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.
When are average cost and marginal cost similar?
When total costs vary in direct proportion to output
When does the total cost function get steeper?
When Q gets larger, and the marginal cost curve must increase in output.
When average cost is a decreasing function of output…?
Marginal cost is less than average cost
When average cost neither increases not decreases in output…?
Marginal cost is equal to average cost
When average cost is an increasing function of output…?
marginal cost is greater
than average cost.
Describe a short run?
The period of time in which the firm cannot adjust the size of its production facilities is known as the short run.
Describe short run average cost function (SAC)?
Includes the annual costs of all relevant variable inputs and the fixed cost of the plant itself.
If a firm knows how much output it plans to produce before building a plant - what should it do to minimize costs?
It should choose a plant size that results in the lowest short-run average cost for that desired output level.
What does long run average cost function exhibit in relation to varying plant sizes?
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
Essentially, firms cannot fully exploit economies of scale unless they have…?
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.
What trend tends to pull down SAC?
as the volume of output increases, average fixed costs become smaller
What can pull SAC up?
Offsetting fixed costs that are spread over an ever larger production volume.
Define sunk costs
Costs that cannot be avoided no matter the decision
Define avoidable costs
Costs than can be incurred or avoided as a result of a decision
What defines economic profit?
Sales revenue minus economic cost
What does the demand curve describe?
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)
When would the law of demand not hold?
If high prices confer prestige or enhance a product’s image, or when consumers can’t objectively assess quality
Define the reverse destruction effect
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
In general, whether marginal revenue is positive or negative depends on…?
price
elasticity of demand
a perfectly competitive firm’s demand curve is
perfectly…?
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.
