Unit 7 - The Firm and its Customers

Question 1

Profit - formulas

Answer 1

Profit = total revenue - total costs
Profit = (price-cost) x quantity
Profit = Q(P-AC)

Question 2

Isoprofit curve definition

Answer 2

Joins the points that give the same level of total profit

Question 3

Profit maximizing using isoprofit curves

Answer 3

• The demand curve determines what is feasible
• Profit max - where demand curve is tangent to isoprofit curve - where the slope of the D curve = slope of the isoprofit curve => MRT = MRS

Question 4

Economies of scale

Answer 4

• the technological advantages of large-scale production
• Cost per unit falls when the firm grows beyond a certain size
• increasing returns - if inputs are increased by a given proportion, output increases more than proportionally

Question 5

Diseconomies of scale

Answer 5

• Diseconomies of scale - limits to growth
• Decreasing returns - if if inputs are increased by a given proportion, output increases less than proportionally

Question 6

Opportunity cost of capital

Answer 6

• the return on investment received if the money would have been invested in something else

Question 7

Marginal Cost

Answer 7

• the additional cost of producing one more unit of output
• it’s the slope of the cost function
• MC = change in cost/change in quantity

Question 8

Economic profit

Answer 8

= the additional profit above the minimum return required by shareholders (normal profit - opportunity cost of capital)

Question 9

Zero-economic profit curve

Answer 9

P=AC at all points on the curve

Question 10

Profit margin

Answer 10

Profit margin = Price - Average Cost

Question 11

Isoprofit curve - the slope

Answer 11

Slope of isoprofit = -profit margin/quantity
- the trade-off the firm is willing to make between P and Q
- the slope of the isoprofit curve will depend on the AC curve (because profit per unit is P-AC)

Question 12

Marginal Revenue

Answer 12

MR = change in revenue/change in quantity

Question 13

Marginal Profit

Answer 13

Marginal Profit = MR - MC

Question 14

Point of Profit Max

Answer 14

MC = MR

Question 15

Consumer Surplus

Answer 15

= the difference between what consumers are willing and able to pay and what they actually pay
- it is a measure of the benefits of participation in the market for consumers

Question 16

Producer Surplus

Answer 16

• Producer Surplus = Revenue - MC
• doesn’t account for fixed costs
  Profit = producer surplus - fixed costs

Question 17

Price Elasticity of Demand

Answer 17

• measure of the responsiveness of consumers to a price change
• PED = %change in q demanded/ % change in price

Question 18

When demand is elastic, the profit margin is …

Answer 18

Profit margin is small + the deadweight loss is small

Question 19

Deadweight loss

Answer 19

• the loss of potential surplus (producer/consumer)
• the existence of deadweight loss means that the allocation is not Pareto efficient
• it’s a consequence of market failure - the unexploited gains from trade

Question 20

Natural monopoly

Answer 20

• when a single firm can supply the whole market at lower AC than multiple firms