theory of supply Flashcards
The slope of the indifference
curve equals what?
the marginal rate of substitution
A change in price implies what?
a change in relative prices
a change in purchasing power
a change in utility
A utility maximizing consumer does what?
sets the MRS equal to the price ratio
sets the marginal utility to price ratio equal for all goods
only buys affordable bundles
The Marginal rate of Substitution is always
constant along an indifference curve true or false
true
Utility maximization implies that the price ratio is
greater than the Marginal Rate of Substitution true or false?
true
The substitution and income effects always work in
the same direction true or false?
true
what do we assume about firms?
We assume firms maximize profit.
Profits formula is?
= total revenue – total costs
Π = TR - TC
what does revenue depend on?
Revenue depends on the demand function
Price x quantity
what does cost depend on?
Cost depend on the firm’s productivity and
input prices.
Expenses incurred by producing goods and/or
services
what is the Principal-agent problem?
the idea where shareholders want different things to managers and cant control them
what is a possible to solution to the principle agent pronblem?
give managers shares
– but managers might game incentives
Accounting costs are….
– Actual payments made by a firm in a given period
Oppurtunity costs are…
Amount lost by not using a resource in its best
alternative use
what is an economists indication of successs?
supernormal profits
what are supernormal profits
Supernormal profit is the pure profit
accruing to the owners after allowing for all
economic costs.
Accounting profits do not necessarily
indicate economic profits!
how do economists analyse profit maximisation?
Economists analyze profit maximization by asking
whether firm should produce additional output or
not.
profit maximizing point is
marginal revenue equals marginal cost.
MC = MR
what is Marginal revenue (MR)?
- the increase in total revenue from selling an
extra unit of output. - is not the revenue from the “last” unit sold.
why does MR steadily fall?
the extra unit must be sold at a lower price
(demand curve slopes down).
price reductions also reduce the revenue earned
from existing units of output
average revenue formula
AR = TR/Q
marginal revenue formula
MR= change in TR/ change in Q
where does MR lie?
MR lies below the demand curve.
MR is less than the price
at which the extra output is
sold.
The inverse demand function
P = a-bq
Economists assume that firms
profit maximise
Firms maximize profit by setting
mc=mr
what does the production function state?
the maximum output that can be produced is, given inputs
Inputs/factors of production
Any good or service that is used in output production
– e.g. capital, labour, natural resources, entrepreneurial ability…
- The inputs used in production determine the
amount of output produced!
what is the short run?
The short run is the period where at least
one input/ factor of production is fixed.
Example: capital (buildings, machinery,
etc.) is fixed in the short run but labour
can vary.
what is an input?
a factor of production
what is the long run?
The long run is the period where no inputs
are fixed, all inputs are variable.
The marginal product
is the increase in output obtained by adding 1 unit of
the variable factor (labour) but holding constant the
inputs of all other factors (capital, etc.)
The marginal value product
the extra revenue from selling the output made by
an extra worker.
– marginal product of labour multiplied by output price
Diminishing marginal product
Also called diminishing returns.
In the short run, the marginal product for a
factor decreases if at least one other factor is
held fixed.
– Trying to increase labour without also
increasing capital will bring diminishing
returns.
– Implies increasing marginal costs.
what do costs depend on?
The firm’s production technology
– The technology gives the possibilities for
transforming inputs into output and is summarized
by the production function.
– Production function: input-output relationship.
* measures the output for given input(s)
– Cost function: cost-output relationship.
* measures total cost given output (and prices)
* Input prices
What is the cost of a specific output quantity?
It is the cost of all the required inputs.
Different (Short-run) Cost Definitions
- Total Costs
–Total Fixed Costs (TFC
)
–Total Variable Costs (TVC
) - Average Costs
–Average Fixed Costs (AFC)
–Average Variable Costs (AVC) - Marginal Costs
what are marginal costs?
Marginal cost (MC) is the rise in total cost
(TC) if output (Q) increases by 1 unit.
– the increase in TC that arises from an
extra unit of production.
– not the cost of producing the “last” unit
marginal cost formula
change in total costs/ change in quantity
As output increases, why might marginal costs
start high, then fall, then rise again?
-In the short-run for given capital increases in
labour specialization might decrease SMC.
– At some point more labour might start to get
into each other’s way and SMC start
increasing.
For 2 goods the long-run production
function would be
y = f (x1,x2)
What happens to output when we double all inputs (t=2)?
is the minimum cost of producing each output level when the
firm can adjust all inputs
Long-run total cost (LTC)
– is the minimum cost of producing each output level when the
firm can adjust all inputs
Long-run marginal cost (LMC)
– is the rise in LTC if output rises permanently by 1 unit
– required for deciding on the profit maximizing output
Long-run average cost (LAC)
– is LTC/Q
– required for checking profit is positive
when is economies of scale on lac curve
When long-run average costs decline as output rises
Reasons:
*Increasing returns
*Indivisibilities (fixed costs)
*Specialisation and division
*Labour
*Capital
Constant economies of scale on a lac curve
When long-run average costs are constant as output rises
Diseconomies of scale on a lac curve
When long-run average costs rise as output rises
Reasons:
* Decreasing returns
* Managerial
diseconomies
* Geography
Minimum Efficient Scale
- The quantity where economies of
scale are exhausted. - A determinant for the intensity of
competition, i.e. the number of
competitors. - If MES is large relative to market size
there will be a few firms only.
where is MES on a lac curve?
lowest point
Which UK industry has the
highest MES as % of market?
steel
If MR > MC, an increase
in output will do
what to profits?
increase them
If MR < MC, a decrease
in output will do
what to profits?
increase them
If the firm is making a
loss when MR=MC what should they do
probably close down
Mr max
MR = 0
what is it if we double all inputs and all outputs double?
constant returns to scale
if we double all inputs and outputs increase by more than twice what is this?
increasing returns to scale
if we double all inputs and outputs increase by less than twice what is this?
decreasing returns to scale
