MicroEcon Flashcards
Economics
Study of how societies should allocate scarce resource among unlimited wants and competing ends
Diff. between positive and normative economics
Positive: the way things are (factual statements)
Normative: the way things should be (opinions for the future)
Cause of scarcity
Unlimited desire for goods and services exceeds the limited ability, resources and time to produce said goods and services
Factors of Production
- Capital (aka. physical capital): manufactured goods necessary in the production process. eg. equipment, tools, building, etc.
- Labor (aka. human capital): the employees and the workers who use their physical and mental capabilities (with the knowledge and skills earned through training and experience) to contribute to the production process
- Entrepreneurship: the ability to identify opportunities, coordinate the production, and ability to accept risk in order to pursue reward
- Natural Resources/Land: Stuff in nature that can be used in the productive process
Opportunity Cost
Value of the best alternative that was sacrificed for the current situation
PPF Graph (Pg. 54) – Define the A, B and C
A = not possible given the limitations in resources B = inefficient use of resources since some resources would go to waste C = Most efficient use of two resources
Efficiency
The usage of all resources as productively as possible
Law of Increasing Opportunity Cost. Why does it occur?
As more resources are dedicated toward a specific good A, the opportunity cost increases because materials that were specialized for the trade-off is also used to produce the good A.
Given a PPF graph, find the average opportunity cost of the good on the x-axis
abs(∆y/∆x)
Given a PPF graph, find the average opportunity cost of the good on the y-axis
abs(∆x/∆y)
Slope of PPF
abs(∆y/∆x)
When is the PPF a line as opposed to a curve?
When the resources used for two goods is not specialized at all and is interchangeable (this is an exception to the law of increasing opportunity cost because the slope does not increase as more resources are given to a specific good.
Diff. between consumer and capital goods
Consumer goods are used directly by the consumer and bought in a retail or consumer market whereas capital goods are used to produce other goods
Relationship between capital goods and future growth and consumer goods and future growth
As more is invested in capital goods, there would be more future growth.
As more is invested in consumer goods, there would be less future growth.
If all resources are used for consumer goods, there would be negative future growth because nothing is invested in the goods that are required to produce more goods in the future (capital goods)
Capital v. Consumer Graph (Pg. 56) – What does point A, B and C represent
Point A leads to considerable future growth
Point B leads to limited future growth
Point C would lead to no future growth
Economic trade-off
Anything of value that is sacrificed for the current investment or situation
Specialization and its purpose
Specialization is when each player in an economy specializes at a good or service due to division of labor.
It enables each person to focus all of their resources on one task they can be better at, increasing overall productivity.
2 categories of economic advantages. Which advantage is relevant when specializing?
Absolute: a player can produce a unit of good at fewer resources than another player. IOW, given the same resources, a player can produce more
Comparative: a player can produce a unit of good at a lower OC than an other player
Players benefit from specialization only due to the existence of comparative advantage
Consumption Possibilities Frontier. If specialization is applied, how does ot relate to PPF?
Demonstrates the possibilities at which consumers can consume. If beneficial specialization is applied, CPF would exceed PPF
Terms of trade. How do you find it.
A trade agreement that aims to reap the benefits of specialization. It should be between the OC of both players.
- Draw a table countries as 1st column and the goods as the 1st row
- Calculate the OC of country A while producing 1 unit of good A
- Calculate the OC of country A while producing 1 unit of good B
- Repeat steps 2 and 3 for country B
- The country w/ the lowest OC for each good should produce the respective good
- The terms of trade is the OC between the OCs of both the countries
Demand Curve. What is it based on?
Graph that displays the relation between the quantity a person demands at a certain price. It reflects marginal utility for each increment of the good.
Demand schedule
Table that displays the relation between price and the quantity demanded
Law of diminishing marginal utility
With each incremental unit of a good, the additional utility gained from it would decrease
Law of demand. What causes it?
As price increase, the quantity demand decreases. Therefore, the quantity demanded is inversely proportional to price of the good. This phenomenon is caused by the law of diminishing marginal utility. Since with each incremental unit the additional utility decreases, the customer is willing to pay less for it.
How do you find the market demand curve, given multiple other demand curves.
Add the demands at a certain price. Plot the sum demand at the total market demand graph at the same price.
What is the premise of most supply and demand models?
The market is perfectly competitive — many firms sell the same product and there is little barrier for entering or exiting the market
Supply curve. Supply schedule
Displays the relation between price and the quantity supplied on a graph (curve) or in a table (schedule)
Law of Supply. What causes it?
As price increases, sellers would be willing to supply more (sell more at greater price; sell less at lower price) Price is directly proportional to quantity supplied. It reflects the marginal cost.
Law of Increasing Marginal Cost
As the quantity supplied increases, the incremental cost of producing a unit of good increases because with additional input, the OC increases since the resources could’ve been used elsewhere. And due to an increased opportunity cost, more price revenue is needed to produce a good.
Market supply curve
How much all the sellers in the market are willing to sell at a given price point. Add the multiple quantities supplied at a certain price point. Plot the sum of the quantities supplied at the price point.
Equilibrium point
Aka market clearing price — Point of intersection between the supply and demand curves. It is the price at which the quantity sellers are willing to supply = the quantity the buyers are willing to buy
Surplus
Quantity supplied > Quantity demanded
Shortage
Quantity supplied < Quantity demanded
What does the economic theory price say about the quantity supplied and the quantity demanded?
Over time, both would gravitate toward the equilibrium point.
Difference between the quantity supplied and supply
Quantity supplied is dependent on the price and displays how much a supplier is willing to supply at a given price.
Whereas supply itself refers to the range of quantity supplies and it displays how much a supplier CAN supply based on market conditions. A positive change in supply means the amount supplied at a given price increases while a negative change in supply means
Is supply directly or inversely proportional to input costs?
Inversely; as costs such as wages, rent, other income increases, supply decreases
Is supply directly or inversely proportional to improvements in technology?
Directly; since tech results in efficient and more productive ways of supplying, enabling the supplier to supply more quantity at a certain price
Is supply directly or inversely proportional to expectations of prices in the future?
Inversely; If the prices are expected to increase in the future, suppliers would decrease the quantity supplied now so that they can supply more for a higher price later; if the prices are expected to decrease in the future, suppliers would increase the quantity supplied at the current higher price
Is supply directly or inversely proportional to the number of sellers?
Directly; The higher number of suppliers, the more quantity would be supplied at the same price at a given point since the total market supply is the summation of all quantity supplied at a given price
Is supply directly or inversely proportional to the price of a substitute in production?
Substitute in production - a good you can produce that uses the same raw materials as the good you are producing. When two goods are substitutes of each other, you can produce one or the other.
Indirect; since if the price of one substitute goes up, the supplier will supply more of the more pricey good and less of the good that brings in less revenue
Is supply directly or inversely proportional to the price of a joint product?
Joint product (complement) - the production of one makes the production of other possible
Directly; if the price of a joint good gets higher, the supplier would supply more of thar good which implies an increase in supply of its joint good
Is supply directly or inversely proportional to taxes?
Indirectly ; Since if a supplier has to pay less taxes for a product, they would supply more of it
Is supply directly or inversely proportional to subsidies?
Subsidies - an incentive provided by the gov to a create a product
Direct; More incentive to create the product means a supplier could produce more of the product at a given price
Is supply directly or inversely proportional to restrictive regulation?
Inversely; If there are less restrictions to making a product, it would be cheaper to make it which would enable a supplier to produce more quantity at a given price
Acronym for factors that cause a shift in supply
R = resource cost O = other goods cost (joint and substitutes) T = taxes, regulation and subsidies T = tech advancements E = expectations of future price N = number of suppliers in a market
3 questions of economics
What goods and services will be produced?
How much of each input would be used to produce each good.
Who will receive the final product?
Allocative efficiency. How do you achieve it?
Allocative efficiency (efficient in output) that the output reflects the needs and wants of the consumers
Since the output can be measured in the marginal cost and the needs and wants can be measured in marginal benefit (the additional amount of dollars the consumer is willing to pay for the additional good), in allocative efficiency, MC = MB (aka marginal value) = Equilibrium Price
Technical Efficiency. How do you achieve it?
Technical efficiency (efficiency production) is achieved when the cost minimization product condition is applied (in which input a is capital where cost is rent and input b is labor where cost is the wage)
(Marginal Physical Product of Input A)/(Marginal Physical Product of Input B) = (Cost of Input A)/(Cost of Input B).
Or
(Marginal Physical Product of Input A)/(Cost of Input A) = (Marginal Physical Product of Input B)/(Cost of Input B)
In both these cases, more bang per buck is preferred since if the ratio on the A-side is higher, more should be invested on the input A, and if more is invested in input A, due to the law of diminishing marginal productivity, the ratio on the input A would decrease. So on and so forth, until both sides produce the optimal and maximum bang/buck.
Distributive Efficiency. How do you achieve it?
Distributive efficiency (efficiency in exchange) holds that the consumer who places the highest value on a good receives that good. It is achieved when:
(Marginal Utility of Good A)/(Price of Good A) = (Marginal Utility of Good B)/(Price of Good B)
Or
(Price of Good A)/(Price of Good B) = (Marginal Utility of Good A)/(Marginal Utility of Good B) – a way to interpret this is that in a perfect world, a consumer is willing to pay $x for good A for every dollar spent on good B because he is getting x amount of Marginal Utility from good A for every additional unit of Marginal Utility from good B
Marginal Rate of Substitution. How does it relate to distributive efficiency?
(Marginal Utility of Good A)/(Marginal Utility of Good B) or how much marginal utility is a person getting from good A for each additional marginal utility from good B
Distributive efficiency is achieved when the marginal rate of substitution is equal for everyone
Marginal Product. How do you calculate it?
Marginal (physical) product is the additional output per period when an additional unit of input is added, holding all other inputs constant. It can be found through the equation
MP (sub input) = ∆TP/∆Input (change in total product for every unit changed in the input)
(Product=physical output, not dollars)
Relation between Marginal Product and Total Product Curve
The directions of TPC and MP are the same because marginal product is the slope of the total product curve
When the MP is increasing, the slope of the TP is increasing. When MP is decreasing, the slope of the TP is decreasing. When MP is 0, the slope of the TP is 0
Law of diminishing marginal returns
As input increases, the marginal return – the output produced for each additional unit of input (slope of the total product curve – eventually decreases, cetris parabus
Average Product. How do you calculate it
AP = Total Product/Total Input (how much does each unit of input produce on avg.)
How does the AP relate to the MP on the Output per Worker and Output Additional Worker vs. the Quantity of Labor Hours graph?
When the MP > AP, the AP increases
When the MP
Relation between the AP and the TPC
The AP = the TPC (Total Product/Input)
Fixed vs. Variable Costs
Total Fixed costs – costs that do not change with the amount of output like rent
Total Variable costs – costs that change with the amount of output like the cost of equipment, workers, ingredients, etc.
How do you find the total costs?
Total Fixed Costs + Total Variable Costs = Total Costs
What is the general shape of fixed costs on a cost v. quantity graph?
It is a line since the fixed cost says the same regardless of the quantity of the outputs
What is the general shape of total variable costs on a cost v. quantity graph?
Increasing since more output requires more workers, capital, etc.
What is the general shape of total costs on a cost v. quantity graph?
Increasing; since more output requires more inputs like workers, capital, etc.
What is the general shape of marginal costs on a cost v. quantity graph?
U-shaped; although at the first few quantities, specialization and productivity increases (decreasing the costs for each additional output and thereby, increasing the amount of output per input – marginal returns), in the latter quantities, the marginal costs increases due to the law of increasing marginal costs and the law of decreasing marginal returns
What is the general shape of average variable costs on a cost v. quantity graph? How do you identify the lowest point on the curve?
U-shaped; although at the first few quantities, specialization and productivity increases (decreasing the costs for each additional output), in the latter quantities, the variable costs increases since the cost per worker increases. The lowest point is when the average variable costs intersects the marginal costs.
What is the general shape of average variable costs on a cost v. quantity graph? How do you identify the lowest point on the curve?
U-shaped; although at the first few quantities, specialization and productivity increases (decreasing the costs for each additional output; thereby, resulting in more outputs per unit inputs – marginal returns), in the latter quantities, the variable costs increase since the cost per worker increases due to law of increasing marginal costs and decreasing marginal returns. The lowest point is when the average variable costs intersect the marginal costs.
What is the general shape of average total costs on a cost v. quantity graph?
U-shaped; although at the first few quantities, specialization and productivity increases (decreasing the costs for each additional output; thereby, increasing the amount of output per unit input – marginal returns), in the latter quantities, the total costs increases since the cost per input increases due to the law of increasing marginal cost and decreasing marginal return. The lowest point is when the average total costs intersects the marginal costs.
Find Total Costs given ATC and quantity
Since ATC=TC/Q
TC=ATC*Q or the area of the ATC v. Q graph
Marginal Cost. What is its relation to the Total Cost Curve and the Total Variable Cost Curve
It is the additional cost of producing one additional increment of output.
MC=TCC=∆TC/∆Q (change in cost per incremental unit)
Since the ratio of the TC to Q is the same as TVC to Q, MC = ∆TVC/∆Q
Marginal Cost. What is its relation to the Total Cost Curve and the Total Variable Cost Curve
It is the additional cost of producing one additional increment of output.
MC=TCC=∆TC/∆Q (change in cost per incremental unit)
Since the ratio of the TC to Q is the same as TVC to Q, MC = ∆TVC/∆Q
Long-Run v. Short-Run
In Short-Run, 1) at least one factor of production or input is fixed (In a simple capital-labor model, the fixed one is the capital while the labor can change) and 2) the firms cannot enter or leave an industry
In Long-Run, 1) none of the inputs are fixed (everything is variable) and 2) a firm can leave a market
Long-Run Average Cost v. Short-Run Average Cost
The total, average and marginal costs are higher in the short run since the fixed input (often, capital) in the short-run is most likely more or less than the cost-minimization amount. Whereas in the long-run the previously fixed-input during the short-run is variable and can therefore be adjusted to the cost-minimization amount.
Relation between economies of scale and LRAC. Why does this phenomenon occur?
Economies of scale: the ability of a firm to mass-produce at a lower cost in the long-run
Therefore, the long-run average cost curve slopes negatively in economies of scale (which means the cost per unit decreases over time.
This occurs due to 3 reasons:
1. Increasing returns to scale (specialization, sourcing etc.)
2. Improvement in technology that becomes economically efficient when mass-producing outputs
3. Costs of one-time inputs (think copyrights etc.) are spread out over a larger amount of outputs.
Relation between diseconomies of scale and LRAC
the LRAC is increasing as output increases
2 possible reasons this occurs include:
1. Coordination issues: more people = more coordinating
2. More expensive inputs and other resources
3. Decreasing returns to scale
Increasing Return to Scale. What kind of firm in relation to cost does it result in.
Output increases more than the increase in inputs in the long-run which contributes economies of scale
Leads to decreasing cost firm
Decreasing Return to Scale. What kind of firm in relation to cost does it result in?
Output increases proportionally less than the increase in inputs which leads to higher costs and thereby, diseconomies to scale.
Leads to increasing cost firm.
Constant Return to Scale
Output increases exactly proportionally to the increase in the amount of inputs
Diminishing Marginal Returns
The output increased due to an additional unit of input (only one input is increased while the others stay constant) – marginal returns – is less than the output increase when the previous unit of input was added – marginal return for the previous input. This is a short-run phenomenon.
Increasing Cost Industry. How does it relate to the long-run supply curve?
An industry that experiences an increase in the avg. production cost in relation to output increase due to increase in the price of inputs caused by an increase in demand.
Increasing long-run supply curve
Timeline: demand for an input increases because producers want to mass-produce an output -> price increases -> cost increases -> increasing cost industry
Constant Cost Industry. How does it relate to the long-run supply curve?
An industry that does not experience an increased avg. production cost with an increase in output. This is because the industry only uses a small fraction of the raw material that it does not impact the demand or the price of the material.
Horizontal long-run supply curve
Decreasing cost industry. How does it relate to the long-run supply curve?
An industry that experiences decreasing average production cost with an increase in output. This is because as the demand for input increases (due to a need to make more outputs), the mass production of inputs occur, leading to lower prices.
Decreasing/negative long-run supply curve
Productive Efficiency. When does it occur
The firm is producing at the lowest unit cost where MC=AC
Economies of Scope. Why do they occur?
When the production of a good reduces the average production cost of another. Think of this as multiple products sharing the same cost. This occurs when:
- two goods are complementary
- multiple goods share research and development costs and distribution networks
Perfect/Pure Competition. How does it relate to productive and allocative efficiency?
A theoretical market structure where supply and demand determines the price and the quantity of goods sold. It is the benchmark for productive and allocative efficiency
What are the characteristics of perfect competition?
- many sellers with each seller only having a small market share (contrary to a monopoly where the entry or exit of a firm has a huge impact)
- little to no barriers to entry or exit for both sellers and buyers
- identical products (so that every seller sells at the same rate and at the same production capacity as every other)
- firms = price takers (who have to accept the price set by the market and can sell as much as they want at that specific price)
- buyers have complete and perfect information about the product (if a seller was to rise the price, the buyers could easily buy from another seller)
Economic Profits. Term for when economic profits = 0. What does it mean?
Total Revenue - Total Cost (both implicit like OC and explicit like rent)
Normal Profits/Breaking Even mean economic profits = 0. It means that the return = the cost
Accounting Profits
Total Revenue - Explicit Costs
Long-run economic profits in a perfect competition
0 since if there is a profit in the market (ATC< MR), more sellers enter the market increasing the supply and lowering the price. If there is a loss in the market (ATC>MR), sellers would leave the market, increasing the price.
Relation between demand for a good and the demand of an input (factor of production)
Directly proportional; Demand goes up -> More people are willing to pay a higher price -> more sellers plan on selling the good -> increased demand in the factor market due to the increased number of sellers
Total Revenue. How do you calculate it?
amount of money earned from the sale of a good
total revenue = quantity of output * price/output
Marginal Revenue. How do you calculate it?
amount of money earned from the sale of one more unit of a good.
Marginal Revenue = ∆TR/∆Q
Average Revenue
Average Revenue = TR/Q
Relation of price, marginal revenue, and average revenue in a perfect competition
Since price (P) is set by the market and the sellers can sell as much as they want at the specific price: P = MR = AR
Identify the following in graph A on Pg. 85
1) Break-even points
2) Profits
3) Losses
1) where TR = TC
2) where TR > TC
a) Maximum Profit is when the TR-TC is at the highest or where the slope of TR = slope of TC (MR=MC)
3) where TC > TR
a) Maximum Loss is when the TR-TC is at the lowest or when the TC-TR is the highest
Find the profit-maximization point through a Profit v. Quantity based on graph A (pg. 85)
y-axis = profit
x-axis = quantity
1) Subtract the total cost from the total revenue at different quantities
2) Plot the dollar amount on the specific quantities
3) The quantity at which the profit is highest is the profit maximization point
4) The quantity at which the profit is lowest is the loss-maximization point
Use Fig. 8 (Pg. 86) to find the following
1) Average Profit at Q*
2) Total Profit at Q*
1) Price (which is equal to MR and AR) - AC*
2) Since Avg. Profit = Total Profit/Q
Total Profit = Avg. Profit * Q
Total Profit = (Avg. Revenue (Price) - Average Cost (at Q*)) * Q
Shutdown Decision
A firm’s decision to temporarily halt sales. Occurs when the Price does not cover the avg. variable cost
What impact does the following have on the firm? (Fig. 9 Pg. 87)
1) P>ATC
2) AVC<p></p>
1) When price greater than the Average Total Cost, most quantity is sold; ideal state
2) When the price less than the Average Total Cost, a lesser quantity is sold because the marginal cost intersects the marginal revenue at a lower quantity; therefore, losses are incurred
3) The firm temporarily leaves the market (shutdowns) because the revenue cannot even cover the variable costs let alone the fixed costs. The firm would only have to pay the fixed costs which is loss minimization.
