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Econ 1 - Midterm 2 Study Guide

by: Elena Stacy

Econ 1 - Midterm 2 Study Guide Econ 1

Marketplace > University of California Berkeley > Economcs > Econ 1 > Econ 1 Midterm 2 Study Guide
Elena Stacy
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This study guide is a bundle of the notes from Week 4 and Week 5.
Introduction to Economics
Monica Deza
Study Guide
monopoly, production
50 ?




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This 6 page Study Guide was uploaded by Elena Stacy on Saturday July 23, 2016. The Study Guide belongs to Econ 1 at University of California Berkeley taught by Monica Deza in Summer 2016. Since its upload, it has received 213 views. For similar materials see Introduction to Economics in Economcs at University of California Berkeley.


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Date Created: 07/23/16
Week 4 Production Function - Production function: the relationship that states that the quantity of output produced depends on the quantity of inputs o In mathematical terms:  Q = f (K, L) • Q represents level of output • K represents capital input • L represents labor input - Inputs: o Fixed inputs: fixed for a period of time, cannot be changed in the “short run” o Variable inputs: the firm can vary this input anytime  “Long run” = however long it takes for all of your inputs to become “variable” - Total product curve: graphical representation of the relationship between quantity of output and quantity of variable input (at a given quantity of a fixed input) Total product curve example (left) Marginal product of labor curve (right) Shifts - Both curves can be shifted if input levels are changed o Example: if a farm has an increase in land available, the TP curve and MPL curve will shift upward (much like a shift in PPF) because at each quantity of workers, each worker will produce more output Marginal product of Labor - The “marginal product” of any input is the additional quantity of output produced by using one more unit of input MPL (Marginal product of labor) = Change in quantity of output / change in quantity of labor Diminishing marginal product of labor: - The first worker is more productive than the last worker o Eventually, hiring another worker returns less increase in output than the first additions of workers, and is thus less beneficial - Seen in the above TP curve (total product curve) as the slope eventually becomes negative as adding more workers eventually leads to less input - Seen in the MPL curve with a constant downward slope similar to the demand curve *Diminishing MPL is a strictly short run concept* Cost curves TC = FC + VC Total Cost = Fixed Cost + Variable Cost Fixed Cost (FC): the cost incurred even when Quantity produced/sold is zero (not dependent on quantity of output produced) Variable cost (VC): cost incurred from variable inputs (dependent on the quantity of output produced) *Industries with large fixed costs are massive producers (in order to offset the burden of these fixed costs) * Total cost curve: relationship between total cost and quantity of output - Upward sloping o Diminishing returns result in a higher cost as quantity of output increases, which causes the upward slope - Marginal cost (review): added cost of an additional unit o MC = change in total cost / change in quantity of output  Recall: Marginal cost curve is also upward sloping Average Total Cost - ATC is generally represented by a U shaped curve o First falls in the lower levels of output and then increases as outputs increase, due to increasing costs o The Marginal Cost (MC) curve intersects the ATC curve at theminimum point of the “U” o Spreading Effect on ATC  Larger outputs result in a wide spread of costs, lowering AFC (resulting in a lower ATC) o Diminishing Effect on ATC  Larger outputs require more variable inputs, raising AVC (resulting in a higher ATC) - These effects are opposite results of the same thing (larger outputs), so the ultimate resulting change in ATC depends on which effect is more powerful at each additional output o At lower levels of output, spreading effect generally dominates, which is why ATC is usually initially downward sloping o At higher levels of output, diminishing effect dominates, which is why ATC begins to slope upward  (The minimum of the U is the point at which neither effect dominates) Computation of Average Total Cost: ATC (average total cost) = TC (total cost)/Q (quantity) = (FC+VC) (fixed costs + variable costs)/Q (quantity) = (FC/Q) (fixed costs / quantity) + (VC/Q) (variable costs / quantity) = AFC (average fixed cost) + AVC (average variable cost) *Note* typical Marginal Cost curves slope downward briefly, and eventually slope upward - initial increasing returns, but eventual diminishing returns Week 5 Market Power: The relative ability to manipulate the market price by affecting supply and demand levels Oligopoly & Monopoly Market Power  Sellers - Monopoly o Only one producer for a particular good and no close substitutes  Protected by a barrier to entry that prevents others from entering the industry i.e. creating substitutes & competition o Natural monopoly: when an industry has large fixed costs, one firm naturally receives a monopoly because it would be disadvantageous for other firms to take on those costs as well  PG & E o Ownership monopoly: a monopolist that sustains their monopoly through control of the resources/inputs needed for the industry  De Beers & diamond mines o Legal monopolies: usually given legal right over a product through a patent or a copyright that prevents others from competing - Oligopoly o Few sellers, many buyers o Arises from same source as monopoly, but in a weaker form o Small number of producers o Interdependence  Firms must observe & predict the behavior of one another  Prices are lower than in monopoly due to imperfect competition being present • Imperfect competition: firms compete but also have market power o Factors that influence coordination  Number of firms  Pricing scheme  Bargaining power of buyers • How to determine if something is an oligopoly? o HHI (Herfindahl-Hirschman Index): square of each firm’s market share of market sales summed over industry - Monopolistic competition o Many competing producers o Heterogeneous products o Free entry & exit from the market in the long run  Toothpaste *Note* Any deviation from perfect competition reduces welfare - price regulations (taxes, price floors, price ceilings) will always reduce welfare in perfect competition, but not necessarily in cases of market power (i.e. monopoly) Interpreting HHI: - HHI < 1,000  strongly competitive - 1,000 > HHI < 1,800  somewhat competitive - HHI > 1,000  oligopoly o If industry HHI > 1,000 merges  Antitrust laws Antitrust Policy: Prevents oligopolists from acting like a monopolist (colluding) Collusion: Firms make agreements with one another to keep prices virtually the same in order to keep market power, sustaining high profits much like a monopolist, rather than lower profits that come as a result of competition - often prevented by antitrust laws Price War: Occurs when firms begin lowering prices in order to steal consumers from other firms in the market, creating a chain reaction of firms lowering prices. Ultimately can be dangerous because prices can become too low to sustain the business and everyone loses profits Product differentiation: customer loyalty, brand advertising targeting certain groups of people in order to differentiate the same product in order to charge different prices Maximizing profits - Profit = Total Revenue – Total Cost - = (Price * Quantity) – Total Cost - In perfect competition P = MC at the profit maximizing quantity - In monopolies, MR = MC at profit maximizing quantity Monopolist profit maximization Perfect Competition Profit Maximization(Recall from past lectures) - A monopolist generally produces a smaller quantity at profit maximization, and charges a higher price, resulting in a larger profit o Profit maximizing quantity and profit maximizing price can be denoted aM Q andMP respectively Monopsony & Oligopsony Market Power  Buyers - Monopsony o 1 buyer  Ex. In the labor force, when there is only one large firm in a town to “buy” labor  Workers are desperate, resulting in the “buyer”, or the firm, having the market power over the workers, allowing them to pay low wages since there is no competition - Oligopsony o Few buyers Basically the same concept as monopsony but there is more than one firm


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