You are on page 1of 10

Questions

Marginal Cost
o (MC) is: The change in total cost attributable to the last unit produced.
At point where mc = atc the average total cost is minimized
When marginal cost is below average total cost, the latter is falling.
When marginal cost is above average variable cost, AVC is rising
Synergy
o occurs when more than one element is combined to produce an effect greater than
the sum of the effects that they would produce independently.
Transaction costs
o consumers- search and switching costs, product heterogeneity, brand
recognitionproducers- access to resources, superior tech, economies of scale
o Transitivity- if two points lie on the same indifference curve they are equal. And
therefore better than the same other goods
o In the short run positive costs at q=0
o
Technology
o Development of New Substitute Products /Lower Transaction Costs Means More
Contestability/ Obsolescence of Current Products
o Improvement in tech= downward shift of MC and increase in output
o
Market Clearing Price
o is the price at which the number of units that people are willing and able to buy is
equal to the number of units that people are willing and able to sell
o Market clearing price and quantity
At equilibrium Qd=Qs
o If you have a demand and supply function, simply set them equal to each other
and solve for price
o
Dead Weight Loss:
o Gains from trades that are not being made.
CS
o Consumer surplus- A measure of the gain that the buyer experiences from an
exchange. (Difference between maximum price willing to pay and what was
actually paid.)
The Market Rate of Substitution
o The rate at which one good can be exchanged for another at current market
prices.
o Px/py
o The Market Rate of Substitution for X with Y is: The amount of Y which must be
given up in order to get one more unit of X, given a fixed budget and market
prices.
o Marginal rate of substitution= We dene the MRS(x,y) as the absolute value of
the slope of the line tangent (write at the hump) to the indiference curve at point
point (x,y).
Utility

o
o
o
o

Marginal utility- Mux= (change in utility/ change in x) change in utility=


(marginal utility of x)(change in x)
Muy= (change in utility/ change in y) (change in utility= marginal
utility of y)(change in y)
Total change in utility= mux*change in x+ muy* change in y
Marginal utility of x/ marginal utility of y = negative (change in y/ change in x)
Diminishing Marginal Utility means: As a person gains more units of a good, the
value of each new unit is lower than the one before.
If the utility for two goods "x" and "y" can be measured as U = x, then it can be
concluded that. the indifference curves on the x,y graph are vertical where "x" is
measured on the horizontal axis

Cartels
o Four reasons why cartels fail on a free market: Cartel members face a
prisoners dilemma There is a high cost of monitoring cartel members Cartel
members can engage in non-price competition The cartel has no way to prevent
new firms from entering the industry
Consumer equilibrium with cobb douglas
o When: U(X, Y) = X^cY^d
o MRSxy=cy/dx
o If mrs is constant (no variables ) then you will only consume one good
o If budget increases and you purchase more of that good than normal
o If budget increases and you purchase less of that good then inferior
Complements if mrs=1
Substitutes if mrs is greater than 1
Unrelated if below 1
Perfect substitutes= mux=muy
o Whenever the MRSXY is higher than the market rate of substitution (px/py), you
should consume more X and less Y
o Consumer equilibrium is the point at which the budget line intersects the
indifference curve at its minimum
o At equilibrium the slope of the indifference curve = slope of the budget line
o Marginal rate of sub= market rate of sub
o Goal is to Maximize utility subject to the budget constraint.
o Math behind consumer equilibrium
Utility maximizing condition states- marginal rate of substitution
MUx/MUy = market rate of substitution Px/Py
Budget line= Px(x)+Py(y)
o
Compensated price changes
o If price go up real income goes down
o If price goes down real income goes up
o An Uncompensated Price Change is: A price change with no change in income.
o A Compensated Price Change is: A price
o change and an income change which, together, leave the consumers utility
unaffected.
Giffen Good
o A good for which the price and quantity demanded have a positive relationship.

In the relevant price range a demand curve for a Giffen good would be upward
sloping
o Requirements
Must be an inferior good
Must have no close substitutes
Must consume a large part of budget
Substitution Effect:
o The change in consumption that results from the change in relative prices.
o Assume that beer is an inferior good. If the price of beer falls, then the
substitution effect results in the person buying more of the good and the income
effect results in the person buying less
Income Effect:
o The change in consumption that results from a change in purchasing power.
Scale
o The range of Economies of Scale is: The range where long run average total costs
decrease as output increases.(increasing returns to scale)
o The range of Diseconomies of Scale is: The range where long run average total
costs increase as output increases. (decreasing returns to scale)
o The concept of Returns to Scale means: The effect that a proportional change in
all inputs has on the level of output.
o

Production Function
o is: The maximum amount of output that can be produced with a given set of
inputs.
o The Short Run Cost Function is: The minimum possible cost of producing each
level of output.
o Joe owns a coffee house and produces coffee drinks under the production
function q = 5KL where q is the number of cups generated per hour, K is the
number of coffee machines (capital), and L is thenumber of employees hired per
hour (labor). What is the marginal product of labor? MP= 5k
o A cubic cost function implies: U shaped ac,mc,avc
o When the average product is decreasing, marginal product is less than average
product
o The slope of the total product curve is the marginal product
o q=f(l,k)
o Goals

Producing on the production function


Choosing the right level of inputs
Optimal Firm Size
o (Minimum Efficient Scale) is: The quantity of production that minimizes long
run average total costs.
MRS
o The Marginal Rate of Technical Substitution (MRTS) is: The rate at which a
producer can substitute between two inputs and maintain the same level of
output.

o
o
o
o
o
o
o

The Marginal Rate of Technical Substitution for L with K (MRTSLK) is: The
number of units of capital a producer can give up in exchange for one unit of
labor while maintaining the same level of output.
The MRTSLK is the negative of the slope of the isoquant curve
Marginal Rate of Substitution (MRS): The rate at which a consumer is willing to
substitute one good for another good and still maintain the same level of
satisfaction.
Marginal Rate of Substitution for X with Y (MRSXY): The amount of Y a person
is willing to give up to get one more unit of X.
Negative change in y/ change in x (negative of slope of indifference curve)
If the MRS is less than Px/Py then we will only consume good x.

Accounting Profit
o means: Total revenue minus explicit cost.
o Explicit Cost (Accounting Cost) means: The amount of money spent on all inputs
to a production process.

Economic Profit
o means: Total revenue minus explicit cost and implicit cost.
o Implicit Cost (Economic Cost) means: The opportunity cost of the money spent
on all inputs to a production process.
o At equilibrium, all industries have the same rate of return.
o At equilibrium, economic profits and losses are zero.
o Economic Rent means: The amount that firms are willing to pay for an input,
minus the minimum amount necessary to obtain it.
o A firm earning an economic profit in the long run has earned a competitive return
on their investments. Whats meant by competitive..the firms return is at least as
large as it could have earned in another investment
Budget constraint
o if good A is on the horizontal axis and good b is on the vertical axis then slope
will equal Px/Py
o Budget constraint graph
o Y intercept= income/price of y
o X intercept = income/price of x
o Budget constraint line equation = M= price of x (amount of x)+ price of
y(amount of y)
o Slope = y= (income/price of y)-((price of x/price of y)*x)
o Increase in income graph shifts to the right. Decrease=opposite
o If food is on horizontal axis and clothing on vertical axis, if price of food falls
relative to price of clothing then the budget line will become flatter
o
Competitiveo In short run is a perfect competitive firm has not shut down then it is operating on
the upward sloping portion of the AVC curve
o A few sellers may behave as if they operate in a perfectly competitive market if
the market demand is very elastic

o
o
o
o
o
o
o
o
o
o
o
o
o

If the market price of a competitive firms output doubles then the MR doubles
Due to a perfectly competitive firms demand curve and marginal revenue curve
the profit max condition for the firm is P=MC
The demand curve facing a perfectly competitive firm is perfectly horizontal (the
same as its average revenue curve and its marginal revenue curve.)
If a competitive firms marginal cost curve is U shaped then its short run supply
curve is the upward sloping portion of the marginal cost curve that lies above the
short run average variable cost curve
In long run competitive equilibrium, a firm that owns factors of production will
have an economic profit = o and an accounting profit greater than 0
Competition in long runThe demand curve for the firm is the equilibrium price:
If price is between avc and atc then a perfectly competitive firm will continue
operating but plan to go out of business
Supply curve for a competitive firm= mc curve above the minimum point of the
avc curve
Introduction of a tax in a competitive industry= left shift in market supply curve
A Competitive Advantage (Barrier to Entry) is: Anything that makes it costly for
new firms to enter a market or for existing firms to expand.
If a graph of a perfectly competitive firm shows that the MR= MC point occurs
where MR is above AVC but below ATC, the firm is earning negative profit, but
will continue to produce where MR= MC in the short run.
The above figure shows the cost curves for a competitive firm. If the market
price is $15 per unit,the firm will earn profits of
Mc above ac
Perfect competition assumptions
Zero transaction costs
No coercive barriers to entry
Perfect comp implications
Firms are price takers
Goods produced at least possible cost
P=MC

o
Elasticity
o Cross price elasticity Given demand function coefficient of good y (price of
good y/Q)
o If the income elasticity of demand=0 then the price increase in entirely composed
of the substitution effect, the income effect associated with a price change is 0
o Cross-Price Elasticity of Demand is: The responsiveness of the demand for a
good to changes in the price of a related good. Substitutes and price of y
increases= demand for x increases; Price of y falls= demand for x falls}
Complements and price of y increases= demand for x decreases; Price of y falls =
price of x increases
(Percentage change in quantity demanded good x/ percentage change in
price of good y)
o Elasticity is: A number that measures the responsiveness of one variable to
changes in another variable. (Percentage change in y/percentage change in x)
o Price elasticity of demand- percentage change in quantity/ percentage change in
price
o If its positive the goods are substitutes

o
o

o
o
o
o
o
o
o

If negative the goods are complements


Income Elasticity of Demand is: The responsiveness of the demand for a good to
changes in income
If positive the good is normal: Income rises demand rises; income falls
demand falls}
If negative the good is inferior : Income rises demand falls, Income falls demand
rises
Own-Advertising Elasticity is: The responsiveness of the demand for a good to
changes in advertising expenditure. (percentage change in quantity demanded/
percentage change in advertising)
Inelastic: When the absolute value of a goods price elasticity of demand is less
than 1.
Elastic: When the absolute value of a goods price elasticity of demand is greater
than 1.

Point elasticity- percentage change in y/ percentage change in x


Price elasticity of demand- (percentage change in quantity demanded/ perc
change in price) X (change in price/change in quantity demanded)
o Own price elasticity of demand- (change in quantity/change in price) X
(price/quantity)
If the demand function is give plug in 0 to find change in price and
quantity
o Cross-Price Elasticity:
If good X and good Y are substitutes, when the price of good X
increases, the demand for good Y increases, and vice versa.
If good X and good Y are complements, when the price of good X
increases, the demand for good Y decreases, and vice versa.
Variable inputs
o Which inputs vary in the long run? All
Price discrimination
o A firm charges a higher price to men and a lower price to women. By doing this
the firm is trying to convert CS into PS
o Perfect Price Discrimination (First-Degree Price Discrimination) means:
Charging the maximum buying price (reservation price) for each unit of a good.
o Quantity-Dependent Pricing (Second-Degree Price Discrimination) means:
Charging lower prices for higher ranges of quantities.
o Third-Degree Price Discrimination means: Charging different groups of
consumers different prices for the same product.
o
Profit maximizing
o inverse demand function(Q)-TC function, set this equal to zero
o At the profit maximizing level of output, marginal profit= 0
o If current output is less than the profit maximizing output then the next unit
produced will increase revenue more than it increases cost
o If current output is less than the profit maximizing output then MR is greater than
MC

o
o
o

In short run If price is below avc (at profit maximizing quantity) then we
shutdown if opposite is true we will produce
The profit maximizing quantity is where MR = MC
If total revenue equals total cost then profit is being maximized (maximizing
quantity)

Profit maximization for a perfectly competitive firm is P=MC


If current output is less than the profit-maximizing output, which must be true
Marginal revenue is greater than marginal cost.
o At the profit-maximizing level of output, what is relationship between the total
revenue (TR) and total cost (TC) curves same slope
Predatory pricing
o in the short run predatory pricing involves pricing the product below avc
Theories
o The Theory of Contestable Markets holds that: When transaction costs are low,
potential competitors are just as good as actual competitors for maintaining
competitive markets.You can never count the number of suppliers and infer
anything about the level of competition in a market
o The Theory of Natural Monopoly is: The theory that in some industries, the
optimal firm size is so large that it is most efficient for one firm to serve the
entire market.
o The Law of Diminishing Marginal Returns states: With a fixed input, and an
increasing variable input, at some point the marginal product of the variable input
must decline.
o
Inferior good
o If the price of an inferior good falls then the substitution effect results in the
person buying more of the good and the income effect results in the person
buying less
o If both goods are inferior then Indifference curve will be bowed out ( like c
facing point 00) moves closer to origin
o
o

Monopoly
o If a firm has a monopoly and faces a downward sloping demand curve for its
product, and its marginal cost curve is upward sloping. If the firm reduces its
price then cs increases and ps may increase or decreases
o Single price monopoly- assumptions= 0 transaction costs, coercive barrier to
entry, only charge one price
o The Predatory Pricing Theory of monopoly is: The theory that a firm can become
a monopoly by lowering its price below its cost and driving all other firms out of
the market.
o Requirements to convict= The products price must be below the firms average
variable cost./ It must be possible for the firm to earn enough monopoly rent to
recoup its losses from the predatory pricing
o Problems= no examples exist, any firm can do this, new firms can always enter
industry, Predatory Theory Assumes That Your Competitor Is Not Your Customer
o
Demand

The Law of Demand is: The principle that there is an inverse relationship
between the price of a good and the quantity demanded
According to the Law of Demand, the demand curve for a good will
slope downward
o Deamand shifters= Advertising and consumer tastes, Number of buyers, Income,
Income elasticity of demand, Prices of related goods
o Inverse demand = put the price on the left side and everything else on right
o Graphing a demand curve
o 1st - Fill in numerical values for all variables except the quantity and the price.
o 2nd- Find the inverse demand function (put the price on the left side and
everything else on the right)
o 3rd- set price equal to 0 this will give you x intercept
o 4th- Use the inverse demand function to find the y-intercept; make sure to
simplify then set qdx equal to 0 to find y intercept
o 5th graph it p on vertical x on horizontal
Producer Surplus:
o A measure of the gain that the seller experiences from an exchange. (difference
between minimum price willing to sell for and actual price sold)
o Long Run Producer Surplus: The amount of economic rent that a seller earns
o If producer surplus is positive then you should produce. Opposite true
o PS= economic profit when fc= 0
o An outward shift in demand causes a rise in both equilibrium p and q. increase in
PS
o Short Run Producer Surplus is: Total revenue minus variable cost.
o Everything to the left of the supply curve under price
o An outward shift in the supply curve causes a fall in market price and a rise in
equilibrium quantity. increase PS
o Total Gain from Trade: The sum of consumer surplus and producer surplus.
o
o

Two-Part Pricing
o (Two-Part Tariff) means: Charging a fixed fee (entry fee) for the right to
purchase a product, plus a per-unit charge for each unit purchased (usage fee).
o The more similar the two demand curves are to each other, the higher the fixed
fee and the lower the per-unit price should be.
o The more different the two demand curves are from each other, the lower the
fixed fee and the higher the per-unit price should be.
Supply
o A Constant-Cost Industry is: An industry whose long run supply curve is
horizontal.
o An Increasing-Cost Industry is: An industry whose long run supply curve is
upward sloping.
o A Decreasing-Cost Industry is: An industry whose long run supply curve is
downward sloping.
o Short run supply curve= The marginal cost curve above the minimum point on
the average variable cost curve:
o The long run supply curve in a constant cost industry is linear and horizontal

o The Law of Supply is: The principle that there is a positive relationship between
o
o
o
o

the price of a good and the quantity supplied.


Supply shifters= number of firms, Input prices, technology
The supply curve for a competitive firm is its MC curve above the minimum
point of the AVC curve.
Supply decreases= supply curve shifts to left
Graphing a supply curve
1st- Fill in numerical values for all variables except the quantity and the
price.
2nd- . Find the inverse supply function (price on left everything else on
right)
3rd- Plug in 0 for the price and it will give you x
4th- Plug in any values into the inverse demand function to find another
point

Shutdown condition
o If you shutdown profits=0-total fixed costs
o If you produce profits= tr X tc
o If profit from producing is greater than profit from shutting down then he should
continue to operate
o In long run a company will exit if p is less than ATC (at profit max quantity)
o A firm does not operate on the downward sloping portion of its avc curve
Isocost
o A curve that shows all the input combinations that will cost the producer the
same amount of money.
General form of the Isocost Line equation: C = wL + rK
Slope = w/r
Cost Minimizing Condition: mpl/mpk=w/r
Isoquant
o A curve that shows all the input combinations that efficiently produce a given
amount of output.
o Q=LK
o K=q/L
o Slope= MPL/MPk
Indifference curve
o Linear. For example when x is dimes and y is nickels
o Slope of indifference curve= -mux/muy
o Indifference curve for perfect substitutes
Linear because you are indifferent between them
o Indifference curve with perfect compliments
It will be L shaped
o find indifference curve given utility function
o 1st set u to any random constant number
o 2nd find values that make that make that utility true
o 3rd plot the values and draw curve
o 4th to find another indifference curve simply change the value of the constant u
o An Indifference Curve is: A curve which shows the set of bundles that each give
a consumer the same level of satisfaction.

o
o
o

Indifference curves are downward sloping because of the assumption of more is


better
Diminishing marginal rate of substitution can be seen when indifference curves
are convex and become flatter aswe move down to right
Assumptions of indifference curves
Completeness
More is better (If bundle A has at least as much of every good as bundle
B and more of some good, bundle A is preferred to bundle B.)
Diminishing marginal rate of sub
Transitivity (indifference curves do not cross)