Microeconomics Final Exam Study Guide
Microeconomics Final Exam Study Guide Eco2023
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This 64 page Study Guide was uploaded by kyrabacon on Monday December 7, 2015. The Study Guide belongs to Eco2023 at University of Florida taught by Mark rush in Summer 2015. Since its upload, it has received 212 views. For similar materials see Principles of Economics: Microeconomics in Economcs at University of Florida.
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Date Created: 12/07/15
Study Guide Final Exam Exam Date: Dec 14th Covers Ch 1 20 in textbook and lectures from the entire class This study guide will cover the most important parts of the chapters in the text and lectures from the class You are allowed one 3x5 index card on this exam, so if there's anything in this study guide that you feel confused about, include it in your index card! Ch 1 (Lecture 2 and part of 3) Economics social science that studies choices that people or businesses make as they cope with scarcity and the factors that influence these decisions Scarcity inability to satisfy all wants Incentive reward/penalty that encourages/discourages an action Difference between macro and micro (in this course, we study micro) Microeconomics the study of individual firms, consumers and markets within the economy Macroeconomics the study of the overall/aggregate economy The three big questions What goods and services will be produced? o Goods: physical objects o Services: tasks performed for consumers How will the g and s be produced? o Factors of production (land, labor, capital and entrepreneurship) For whom will they be produced? o Landrent o Labor wages (earns most) o Capital interest o Entrepreneurship profit Economic structure Tradition the answer this year is the same as last year (follows a pattern) Command Economic planners devise answers and create plans (ex: North Korea) Consider: Selfinterest vs. social/public interest Selfinterest best decision for yourself Social Interest best decision for everyone ▯ Economists favor efficient resource use no one can be better off without someone else being worse off There are five things that Rush does not talk about in his lectures from this chapter, but he includes about 510% of his questions from the book, so it might be helpful to know. Issues in today's world regarding social vs.self interest o Globalization (expansion of trade and investments) o InformationAge Monopolies (Information Revolution) o Climate Change (Burning fossil fuels for use) o Financial Instability (unpaid loans) Economic way of thinking Tradeoffs giving up one thing to get something else Rational choices comparing benefits (gains) and costs (give up) o Benefit determined by preferences (what a person likes/dislikes) o Opportunity cost highest valued alternative given up ▯ Ex: Sally loves both tacos and pizza. Both cost $4. Sally would rather get a taco than a pizza slice. When she gets a taco, her opp. cost is the pizza slice. Choices made at the margin compare benefit of more of something with its cost o Marginal Benefit benefit received from one more unit consumed ▯ Measured as max amount willing to pay for one more unit Marginal Cost opp cost of producing one more unit ▯ Measured as increase in total cost/increase in output Respond to incentives (see first bullet) Positive v. Normative Statements Positive: what is Negative: what should be Economic model explains economic world descriptions of some aspects that include only features needed for purpose at hand Ch 2 (Lectures 37) Production Possibilities Frontier (PPF) boundary between combinations of g + s that are produced at lowest possible cost Good A Not Attainable and production efficient Attainable but not Good B There is no opp cost from going to production inefficient to pro. eff. Choice along PPF (as you move along line) is a tradeoff Point may be located inside because resources are not being used efficiently Law of increasing opportunity cost bowed outward because resources are not equally productive at each point o Opp cost= lose/gain o Allocative Efficiency g+s produced at lowest cost with greatest benefit (in other words, you can't produce more of one without giving up other) PPF shows limits to production o Resources (labor, capital, land and entrepreneurship) ▯ If resources increase/decrease, PPF bows outward/inward o Technology Marginal cost is slope of the PPF Marginal Benefit Curve shows marginal benefit and quantity consumed (unrelated to PPF curve o Similar to demand curve o principle of decreasing marginal benefit (more of good, less marginal benefit) ▯ Ex: 1st slice of pizza has more benefit to you than the 10th slice of pizza, when you're not as hungry Economic growth expands PPF outward Ex: Hong Kong catching up to US Good A Good B Technological change development of new goods or ways to produce Capital accumulation growth of capital resources (including human capital) Need to know terms (economic coordination) Firm economic unit that hires factors of production to sell g+s Market arrangement that allows buyers and seller to get info and do business o Competitive no buyer or seller influences Property rights social arrangement that governs ownership and use of valued property (real, financial and intellectual) Money commodity or token accepted as payment Trade Gains (Rush doesn't mention this until Lecture 20, but its included in Ch 2, so I'll mention it here) Comparative Advantage country/person can perform activity at lower cost than others (ex: Suppose US outperforms China in rice and shirt production, but is better at producing shirts than rice, so China produces the rice) Absolute Advantage country/person is more productive than others in all activities (ex: Suppose US outperforms China in rice and shirt production) Ch 3 (Lectures 8 ) *This chapter is most crucial of all, I recommend you research it more in depth in addition to the study guide! Markets and Prices Competitive Market See markets in Ch 2 Money price dollars exchanged for good or service Relative price ratio of one price to another (opportunity cost) Demand Law of Demandhigher the price of a good, the smaller the quantity demanded and lower the price, higher the quantity demanded (P QD and vice versa) Demand entire relationship between price of good and QD o want, afford and plan to buy Quantity demanded amount of a good or service that consumers plan to buy during a given time period at a particular price (point on demand curve) o Change in QD (caused by change in price) indicates a movement along the demand curve Demand Curve relationship between QD and its price (other influences constant) Price Quantity Demanded Change in Demand o Indicates a shift of the demand curve o *The way I remember change in QD or change in demand is that movement is two syllables move and ment, just like quantity demanded is two words. Shift is one syllable, like how demand is only one word. (This can also apply for supply). Hope this helps :) o Caused by 6 factors ▯ Price of related goods Complement good used with another good Substitute good that can replace another good ▯ Expected future prices ▯ Income Normal gooddemand increases as income increases Inferior good demand decreases as income increases ▯ Credit market conditions ▯ Preferences ▯ # of demanders Supply Law of Supply The higher the price of a good, the greater the quantity supplied of it, and the lower the price, the lower the QS Price Quantity Supplied Supply entire relationship between price of good and QS Supply Curve relationship between QS and price (other influences constant) o See curve above Quantity supplied amount of good or service that producers plan to sell during a given time period at a particular price o Change in QS (caused by change in price) indicates movement along the supply curve Change in Supply o Indicates a shift of the supply curve o Caused by 6 factors ▯ Cost (of factors of production) ▯ Technology ▯ # of suppliers ▯ Price of related goods Subs in production uses same materials (ex: leather wallets and leather belts) Comps in production produced together (beef and cowhide) ▯ State of Nature (natural occurrences that affect resources) ▯ Expected future prices (opposite demand pattern) Market Equilibrium Equilibrium price price where QD = QS Equilibrium quantity quantity bought and sold at equilibrium price P S EP D EQ Q If QD > QS, then price is too low and there is a shortage, and the price goes up If QS > QD, then price is too high and there is a surplus and the price goes down Shifting the Demand OR Supply Curve P and Q rise = demand curve shifts right P rises and Q falls = supply curve shifts left P falls and Q rises = supply curve shifts right P and Q fall = demand curve shifts left Shifting both Demand and Supply D shift> than S shift = P and Q rise D shift< than S shift = P falls and Q rises Rush's 4step method for shifts of supply OR demand curves 1. Draw demand and supply diagram 2. Which curve shifts? 3. Determine direction of shift 4. Draw a new line Ch 4 (Lectures 1214) Price Elasticity of Demand responsiveness of the QD of a good to a change in the price % change QD/ % change P o You can calculate the % change in P or QD with the formula: (% change in P) / (average price x 100) o Ex: Original price of pizza was $20.50 and the new price is $19.50. The price change is $1 and the average price ((19.5 + 20.5)/2) is $20, so 1/20 is 5%. o Use the Slope Formula (rise/run) to find change in P/change in QD ▯ Still confused? Try combining the two formulas into the commonly used MidPoint Formula: change in QD / average QD change in P / average P ▯ *The elasticity is the magnitude of response we know if it's negative or positive based on Law of Demand, so it's always expressed as a positive Types of Elasticity o "Perfectly Elastic"demand with an infinity price elasticity (vertical demand curve) o Elastic E>1 (almost vertical) o "Perfectly Inelastic" demand with zero price elasticity (horizontal demand curve) o Inelastic 0<E<1 (almost horizontal) o Unit Elastic E = 1 (% change in P = % change in QD) Factors that Influence Elasticity # of substitutes Proportion of income spent Time elapsed since price change (Rush doesn't include this, but it's in the book) *Elasticity changes as you go down a downward slope Total Revenue Test method of estimating price elasticity of demand by observing change in total revenue results from a change in price o Total Revenue value of firm's sales ▯ P of good X QD E=infinit y E>1 E= 1 E< 1 E= Other types of Elasticities of Demand Cross E. of D. responsiveness of demand for a good of a sub or comp o (% change in QD) / (% change in price of sub(+)/comp()) ▯ Helpful Hint: Substitute= Positive, Complement= Negative Income E. of D. responsiveness of demand to change in income o (% change in QD) / (% change in income) ▯ IED>0 = normal good ▯ IED<0 = inferior good Price Elasticity of Supply responsiveness of QS of a good to change in price (% change in QD) / (% change in income) Similar to P.E. of Demand with graphs and elasticity Two factors affect magnitude of elasticity (Rush doesn't mention these, but they're in the book, so I suggest studying them a bit) o Resource substitution possibilities ▯ productive resources available, then E will be greater o Time frame for the supply decision ▯ Momentary supply (response of sellers to a price change at the very moment it changes) ▯ Shortrun supply (response after some adjustments, such as technology, are made) ▯ Longrun supply (response made after all adjustments are made) Ch 5 (Lecture 15, 16 and part of 17) Allocation of resources (Rush doesn't mention this in his lectures, so I'll be brief, but it's good to know, just in case) Market Price Command system someone of authority allocates Majority rule Contest Firstcome, firstserved Lottery Personal Characteristics (Ex: Marriage) (In the workplace, this is not allowed) Force (Ex: military, war) Demand and Marginal Benefit Marginal Analysis compares marginal benefit to marginal cost o MB>MC, do action o MB<MC, don't do action o Ex: The director has eaten 4 slices of pizza at $4 a slice. All his slices combined are his total benefit, but the benefit he gets from eating a fifth slice is his marginal benefit (max price willing to pay for next slice) o Marginal Benefit = marginal social benefit (demand curve) ▯ Benefit to consumer from one more unit of good ▯ When Q rises, MSB falls ▯ When Q falls, MSB rises o Marginal cost = marginal social cost (supply curve) ▯ opp. cost of producing one more unit (producer) ▯ When Q rises, MSC rises ▯ When Q falls, MSC falls Allocative Efficiency one point on PPF where it is not possible to produce more of one good without producing less of another valued more (see ch 2) MSB = MSC Total Surplus EP Allocatively Efficient Quantity (same as Equlibrium) EQ Consumer Surplus EP All. Eff. (Equ.) Producer Surplus Total Surplus sum oEQconsumer and producer surplus (measures efficiency) Consumer Surplus (marginal benefit price paid) / quantity bought Producer Surplus (price marginal cost) / quantity sold o Finding areas of surpluses = area of triangle (1/2BH) Market Failure market delivers inefficient outcome Underproduction = Deadweight Loss measure of inefficiency, decrease in total surplus due to inefficient production Overproduction = deadweight loss from surplus Under (DWL) Over (DWL) Sources of market failure (Again, Rush doesn't include this, this is from the book) o P and Q Regulations o Taxes and subsidies o Externalities o Public goods and common recources o Monopoly o High transaction costs opp. costs of trades in market Fairness of Market and Theories Adam Smith "Suppliers and demanders pursue selfinterest and social interest at the same time." (Invisible Hand) Rules of fairness (book, not Rush) o Not fair if the result isn't fair ▯ Utilitarianism principle that states that we should strive to achieve "the greatest happiness for the greatest # of people" ▯ Big tradeoff tradeoff between efficiency and fairness ▯ Make poor welloff (John Rawls A Theory of Justice) o Not fair is rules aren't fair ▯ Symmetry principle people in similar situations treated similar ▯ Fairness rules (Robert Nozick Anarchy, State and Utopia) 1. State enforces laws that establish and protect private property 2. Private property transferred voluntarily Ch 6 (Lectures 1720) Price Ceiling/ Price Cap government sets max legal price that can be charged (ex: rent) Rent ceiling price ceiling for rent o Effects ▯ Black Market markets in which otherwise legal goods are traded at an illegal price (ex: key money) ▯ Search activity time spent looking for someone to buy or sell a good ▯ Housing shortage (QD>QS) ▯ Only sellers and buyer with little search gain, society loses Shortage S Unemployment Equilibrium P/Q Min Wage Price Ceiling EP/EQ D QS QD QD QS Price Floor government sets minimum legal minimum price (ex: agricultural products) Minimum Wage regulation that makes hiring of labor below a specified wage rage illegal o Effects ▯ Illegal hiring some workers and firms agree to wages lower ▯ Search As workers search for jobs, they're unemployed ▯ Only workers who find jobs with little search and labor unions gain, all businesses and unemployed workers lose, society loses Taxes Tax Incidence division of burden of tax between buyers and sellers Supply curve shifts up by amount of tax Ex: Tax of $2 Seller pays $1 and buyer pays $1 EP + tax = $4 Government tax revenue = Tax X EQ CS, DWL, PS (triangles on graph) EPPS = $2 EQ Tax incidence depends on Price Elasticity of Demand o PED > PES (elastic) = suppliers pay more of tax o PED < PES (inelastic) = demanders pay more of tax Taxes and Fairness (book, not Rush) Benefits Principle people should pay taxes equal to the benefits they receive from the services provided by government (benefit most = pay most) Ability to pay principle people should pay taxes in accordance with their ability to pay Production Quotas and Subsidies (Ex: Farming) (Again, book, not Rush) Production Quota upper limit to quantity of good that may be produced (has effect only if below EQ) o Effects ▯ decrease in supply ▯ rise in price ▯ decrease in marginal cost ▯ inefficient underproduction ▯ incentive to cheat and overproduce Subsidies payment made by government to a producer (mostly to agricultural products) o Effects ▯ increase in supply ▯ fall in price and increase in QD ▯ increase in marginal cost ▯ payments by government to farmers ▯ inefficient overproduction Market for Illegal Goods (book, not Rush, so I'll be brief) Penalties on sellers (ex: illegal drugs) additional cost in production and supply decreases (curve shifts to left) Penalties on buyers (ex: illegal drugs) additional cost to buy and demand decreases (curve shifts to left) Penalties on sellers and buyers both supply and demand curves shift (ex: Penalty is higher on sellers of illegal drugs than buyers, so supply curve shifts more than demand, causing the price to rise) Ch 7 (Lectures 20 and 21) Imports goods and services that we buy from other countries Exports good and services that we sell to other countries Comparative and absolute advantage (see Ch 2) o Ex: China outperforms US in tshirt production, but US outperforms China is airplane production Exports World Price EP EP World Price Imports EQ EQ Effects of Exports o Winners: Producers and Society o Losers: Consumers Effects of Imports o Winners: Consumers and Society o Losers: Producers Trade Restrictions Tariff tax on a good that is imposed by the importing country when an import crosses an international boundary (works like a tax, see tax graph in Ch 6) o P rises, QD falls, domestic prod. rises, imports fall and tariff revenue created o Effects ▯ Losers: Consumers and Society ▯ Winners: Producers and Government Import Quota restriction that limits max quantity of a good that may be imported in a given period (shifts supply curve to the right) o P rises, QD falls, imports fall, domestic prod. rises and DWL created o Effects ▯ Losers: Consumers and Society ▯ Winners: Producers and Importers Other Import barriers regulatory (book, not Rush) o Health, safety (ex: beef imports fall, with mad cow disease) o Voluntary export restraints governmentimposed restrictions on exports o Export subsidies government payments to producers of exports (illegal) The Case Against Protection (book, not Rush) Trade restrictions help because... o Helps infant industries grow (needs time to become productive enough to compete with international companies) o Counteracts dumping foreign firm sells exports at lower price than its cost of production to undercut domestic businesses o Saves domestic jobs o Allows US to compete with cheap foreign labor o Penalizes law environmental standards o Prevents rich countries from exploiting developing countries o Reduces offshore outsourcing US firms buy finished goods or service from firms in other countries Why is international trade restricted? Tariff revenue goes to government Rent seeking lobbying for special treatment by government to create profit or divert consumer/ producer surplus away from others Ch 8 (Lectures 22, 23 and part of 24) Consumption Possibilities (book not Rush, not very important so I'll be brief) All the things you can afford to buy Budget Line marks boundary between combinations of goods and services that an individual can afford and can't afford to buy. Utility benefit or satisfaction a person gets from consumption of goods and services Total Utility all of the benefit a person gets from consuming all goods and services Marginal Utility change in total utility resulting from a oneunit increase in quantity consumed o (change in TU) / (change in Q) Diminishing Marginal Utility increases in utility get smaller as consumptions rises Units of Utility Quantity Consumed o Consumer Equilibrium consumer allocates all available income in the way that maximizes their total utility, using the prices of such goods and services o Marginal Analysis compares MU/dollar on each good ("bang for your buck") ▯ Marginal Utility per dollar marginal utility that results from spending one more dollar on a good (MU / P) ▯ UtilityMaximizing Rule Spend all available income Equalize MU/dollar o Ex: Sam loves pizza and soda. Both cost $4, and his income in $20. Pizza Soda Q TUTU M MUMU/PMU/ U P 0 0 1 16 160 40 Pi0z Sod TU 2 a8 12a 30 50 0 0+460=460 3 36 801 2020+240=660 Greatest 30 2 360+320=680 Utility 2 3 280+360=640 4 12 604 1160+380=540 00 5 0+388=388 5 46 40 10 0 Predictions using Greatest Utility Theory Ex: Q Movies cost $8, soda costs $4, and Lisa's 0 0 income 1 240 240 60 is $40. She decides to see 2 movies and buy 6 2 320 80 20 cases of soda o What happens if there is a fall in the 3 360 40 10 4 380 20 5 price of the movies? 5 388 8 2 ▯ Calculatin g her utility for movies and soda, Lisa will buy 6 movies and 4 cases of soda. o What happens if there is a rise in the price of soda? ▯ Calculating her utility for movies and soda, Lisa will buy 6 movies and 2 cases of soda o What happens if there is a rise in her income? ▯ Calculating her utility for movies and soda, Lisa will buy 8 movies and 6 cases of soda Paradox of value (Ex: Diamonds worth more than water) TU of water > TU of diamonds but... MU of water < MU of diamonds Explaining Consumer Choices (Rush doesn't really mention this, but the book includes it) Behavioral Economics study of ways limits on human brain's ability to compute and implement rational decisions influence economic behavior o Bounded rationality o Bounded willpower o Bounded selfinterest o Endowment effect Neuroeconomics study of activity of human brain when a person makes an economic decision Ordinal v. Cardinal Utility (Rush, not book) Ordinal Utility Assumes a person can tell us if a change makes them better off, worse off or no change Cardinal Utility Assumes we can measure a person's utility o In this chapter (Ch 8), we use cardinal utility. A prime example of cardinal utility is insurance, which will be Ch 20, but Rush briefly explained a bit of ordinal utility, which is Ch 9 Ch 9 (Part of Lecture 26) *Don't worry it's not the whole chapter just part about ordinal utility Indifference Curves consumer is indifferent among any combination of goods on an indifference curve Person prefers each point ( ) in relation to initial point ( ), but indifferent to ( ) Bread Wine Ch 20 (Lectures 2426) Insurance uses cardinal utility (see Ch 8) to study decisions under risk Risk Aversion dislike of risk o Ex: Mark has a car. His car is worth $5,000 with no accident but only $1000 with an accident. Wealth/Income TU MU (per $1,000) 0 0 $1000 150 150 $2000 250 100 $3000 300 50 $4000 330 30 $5000 350 20 Mark has a 50/50 chance of having an accident so without insurance... Car Worth Utility 50% No Accident $5000 350 50% Accident $1000 150 Expected Wealth money value of what a person expects to own at a given point in time EW = ($5000 x 0.5) + ($1000 x 0.5) = $3000 Expected Utility utility value of what a person expects to own at a given point in time EU = (350 x 0.5) + (150 x 0.5) = 250 Will Mark buy this insurance policy if the premium is $2000 and it pays $4000 with accident and $0 with no accident? With Insurance Car Worth Utility 50% No Accident $5000 + $0 (insurance pays) 300 $2000 (premium) = $3000 50% Accident $1000 + $4000 $2000 = $3000 300 EU = (3000 x 0.5) + (3000 x 0.5) = $3000 EW = (300 x 0.5) + (300 x 0.5) = 300 *EU w/ insurance > EU w/out insurance, so Mark will buy the policy Insurance: Supply Ex: With a Premium of $3000, will the company sell insurance? o Revenue per person $3000 o Expected Cost ($4000 x 0.5) + ($0 x 0.5) = $2000 o Expected Profit = (Revenue Cost) or $3000 $2000 = $1000 ▯ The company makes a profit of $1000, so yes they will sell Increased Risk? (80% accident, 20% no accident) o Rev $3000 o EC (4000 x .8) + (0 x 0.5) = $3600 o Expected Profit = $3000 $3600 = $600 ▯ The company would have to increase its premium to sell Private Information info about the value of an item being traded that is possessed by only buyers or sellers (asymmetric) Adverse selection tendency for people to enter into agreements in which they use their private information to their advantage (Companies can sell policies to people who are riskier than they thought) o Ex: Bank lends loan and knows risk that creditor may default on loan (credit/default risk) o Signaling consumers signal ways that show their level of risk (ex: grades) o Screening sellers require private info about person to determine level of risk and sell policy appropriate to their risk level Moral hazard tendency for people with private info to use such info to their benefit and cost of uninformed party Lemons problem problem that in a market, it's not possible to distinguish reliable products from bad products (lemons) o Pooling equilibrium equilibrium of market when one message is sent out to all consumers and no one can determine quality o Separating equilibrium equilibrium of market when signaling provides full info to a previously uninformed party Ch 9 (Lectures 26, 29 and 30) Indifference Curves consumer is indifferent among any combination of goods on an indifference curve Person prefers each point ( ) in relation to initial point ( ), but indifferent to ( ) Bread Steep slope = high MRS Flatter slope = low IC2S Wine Bowed in due to MRS Marginal Rate of Substitution (MRS) magnitude of slope on indifference curve (IC) (absolute value) Decreasing MRS MRS decreases as you move downward along an IC Budget Lines limit to a household's consumption choices, marks boundary between what they can and can't afford Real income household's income expressed as a quantity afforded Relative price ration of price of one good to the price of another (opp cost) Think of Qw Qb PPF 0 20 Qb Unaffordable Ex: Income = $10 1 16 Pw = $2 2 12 3 Affo8dable + Efficient Pb = $0.50 4 4 0 5 Aff. + Ineff. Qw Income/ Budget Constraint o (Pw X Qw) + (Pb X Qb) = Income Pw X Qw Pw X Qw P X Qb = Inc (Pw X Qw) Pb Pb Pb Qb = Pw X Qw + Inc Pb Pb o Remember Y = MX + b? Q Inc b Pb ▯ M is slope, b is vertical intercept so... o Qb = Pw X Qw + Inc Slope = _ Pw Pb Pb Pb o Y = MX + b Changing the Budget Line What happens when price changes? (Price effect) Q Qb Qb w What if Pw decreases What if Pb decreases? Pw rises? Pb rises? Qw Qw o A fall in price rotates budget line outward o A rise in price rotates budget line inward What happens if income changes? (income effect) o A fall in income shifts budget line inward o A rise in income shifts budget line outward Degree of Substitutability (Indifference Curves) Perfect substitutes linear graph Perfect complements Lshaped Subs Comps Indifference Curves with Budget Lines Point lies on IC 2 and is int is preferable to point therefore less desired than a Point is preferable to point point on IC 3 Point is the best affordable point because IDC 3 is preferable to IC 2 and this point lies both in IC 3 and on the budget line Point is unattainable because IC 4 does not touch the budget line and is Budget unaffordable. Line If price or income changes, as seen in graphs involving price and income changes, then a new budget line is created and anything outside of that budget curve is unaffordable and therefore a new best affordable point is created. Indifference curves are also used to plot a demand curve. As price falls or rises, the demand of an individual falls or rises consequently o This proves the Law of Demand With ICs, we assume that 1. People want to maximize utility 2. People can tell if change helps/hurts/doesn't change 3. MRS decreases down along IC Ch 10 (Lectures 30, 31) Rush doesn't go into detail in Ch 10, so I'll include the bare essentials Firm institution that hires factors of production and organizes those factors to produce and sell goods and services Goal is to maximize economic profit total revenue minus total cost o Total cost is the opportunity cost of production using resources ▯ bought in the market ▯ owned by the firm Implicit Rental Rate firm's opp cost of using capital it owns economic depreciation fall in market value of a firm's capital forgone interest opportunity cost of earning interest on funds that could have been reallocated ▯ supplied by firm's owner Owner might supply entrepreneurship and labor Normal Profit average profit earned by entrepreneur Firm's decisions 1. What to produce and what quantities 2. How to produce 3. How to organize managers and workers 4. How to market and price products 5. What to produce itself and buy from others ▯ Constrained by Technology method of producing good or service Information lack for future and present Market prices and marketing of other firms Technological and Economic Efficiency Technological Efficiency firm produces given output using least amount of input Economic Efficiency firm produces given output at the least cost Information and Organization Command system method of organizing production using managerial hierarchy Incentive system method of organizing production that uses a marketlike mechanism inside the firm o PrincipleAgent Problem problem of devising compensation rules that induce an agent to act in the best interest of a principal ▯ Solving the problem Ownership Incentive Pay Longterm contracts Types of Business Organization o Proprietorship firm with single owner who has unlimited liability o Partnership firm with 2 or more partners who have joint unlimited liability o Corporation firm owned by limited liability stockholders Markets and the Competitive Environment Perfect Competition many firms, each selling an identical product, many buyers and no restrictions on the entry of new firms into the industry Monopolistic Competition market structure with a large number of firms competing by making similar but slightly different products (product differentiation) Oligopoly market structure in which a small number of firms compete Monopoly one firm that produces good with no close substitutes and protected by barrier preventing new firms from entering market o Measures of concentration used to determine extent of markets ▯ fourfirm concentration ratio percentage of value of sales accounted for by four largest firms in industry (0100) 0 = perfect, 100 = monopoly ▯ HerfindohlHirschman Index square of the percentage market share of each firm of each summed over the largest 50 firms small = perfect, large = monopoly o Limits of Concentration Measure ▯ geographical scope of market ▯ barriers to entry and firm turnover ▯ correspondence between a market and an industry Markets are narrower than industries Most firms make several products Firms switch markets Produce or Outsource? Firm Coordination coordinating production of various goods and activities Market Coordination adjusting prices and making decisions of buyers and sellers consistent o Firms are more efficient because ▯ Lower transaction costs costs that arise from finding someone with whom to do business with ▯ Economies of scale cost of producing a unit of a good falls as output rate increases ▯ Economies of scope specialized resources to produce a range of goods and services ▯ Economies of team production individuals in a group specialize in mutually supportive tasks Stock Market (Rush, not book) *Highly recommended to read the stock market essays on Canvas, Rush hinted they might be on the test Higher rates of return Corporations o one or more shareholders with a board of directors that oversees managers ▯ Shareholders own, executive managers run ▯ Board of directors has to approve large decisions and give advice Elected by shareholders How does a company get finances? 1. Issuing stock 2. Borrowing (banks and bonds) Terminology o Market cap = measures business worth o Average volume = # of shares sold and bought in one day o EPS = earnings per share o DIV & Yield = dividend or payment for shares ▯ Some companies don't pay dividends 1. small or nonexistent profits 2. strong growth prospects o Capital Gain/Loss = current price price bought at o P/E = Price/earnings ratio (price / EPS) Ch 11 (Lectures 32, 33 and part of 34) Production Function F(L, K) = Q F = firm, L = labor, K = capital and Q = quantity supplied L and K are inputs, Q is output Speed of change in L and K differ Short run a period of time over which at least one input is fixed Long run a period of time long enough so that all inputs can be varied Short Run Long Run L Variable Variable K Fixed Variable ▯ Ex: K L Q MPlab FC V TC C 2 0 0 $6 $0 $6 2 1 5 5 6 4 10 2 2 1 7 6 8 14 2 2 3 1 6 6 12 18 8 2 4 2 4 6 16 22 2 2 5 2 1 6 20 26 3 ▯ Marginal Product of Labor (MPlab) = change in Q / change in L Diminishing MPL = As L increases, eventually MPL decreases ▯ Fixed costs fixed inputs ▯ Variable costs variable inputs ▯ Total cost FC + VC = TC Measures of short run Total product max output that a given quantity of labor can produce o Similar to PPF in that a firm can only produce using a set amount of labor, but can't produce outside the total product curve. Only points on the curve are efficient Marginal product increase in total product that results from a oneunit increase in the quantity of labor employed o Law of diminishing returns As a firm uses more of a variable factor of production with a fixed quantity of the fixed factor then the MP eventually diminishes Average product equal to TP / QL o Average product highest when = MP Costs of short run Total fixed, variable and total cost cost of all factors Average fixed, variable and total cost total costs per unit of output o AFC = FC / Q o AVC = VC / Q o ATC = AVC + AFC or TC / Q Marginal cost increase in TC that results from oneunit increase in output o (change in TC) / (change in Q) Marginal/Average relationship o If M? > A?, then A? rises o If M? < A?, the A? falls Shifts in cost curves o Technology productivity increase = MP and AP of labor increase o Prices of factors of production price increase = firm's costs increase Long run Production Function and diminishing returns (see above) Longrun average cost curve relationship between the lowest attainable average total cost and output when the firm changes both production and labor (Ushaped) Economies of scale features of firm's technology that make average cost fall as output increases (LRAC curve slopes down) Diseconomies of scale features of a firm's technology that make average total cost rise as output increases (LRAC curve slopes up) Constant returns to scale features of firm's technology that keep ATC constant as output increases (LRAC curve slope is constant) o Minimum efficient scale smallest output at which longrun average cost reaches its lowest level Graph (Sorry I couldn't replicate it on the computer, so I hand drew it. Hope it helps) Ch 12 (Lectures 34 36) Perfect competition factors lots of firms and buyers Products produced are identical no "barriers to entry" (legal or costbased) o Price takers firm that cannot influence the market price because its production is an insignificant part of the total market o Total revenue P X Q o Marginal Revenue (change in TR) / (change in Q) MR Q P TR 20 $5 $100 $5 21 $5 $105 $5 22 $5 $110 P Firm Market S $5 D = MR $5 20 40 q 35 D MC MC < MR MC > MR $5 D = MR $1.20 $1 Produce where MC = MR 1 5 q* Total Profit = (P X q*) (ATC X q*) Economic Profit occurs when the profit is above average o P > ATC Normal Profit is average profit o P = ATC Economic Loss occurs when the firm produces below average profit o P < ATC o Shutdown Point Rule: ▯ If P > ATC, then the firm will stay open ▯ If P < ATC, then the firm will close In the short run, a firm will stay open even with a loss due to FC, but in the long run, it will close when its FC becomes VC. Market and Firm in changing supply When D shifts R, P rises, but in long run S shifts with more suppliers and P falls back P S S' P P* P* D D ' Q q* q' q Ch 13 (Lectures 37 38) Monopoly one firm that produces products with no close substitutes and insurmountable barriers to entry into its market. Barriers to entry ownership, legal or natural onatural monopoly economies of scale enable one firm to supply entire market at the lowest possible cost (cost based) olegal monopoly competition and entry restricted by granting of legal rights Demand always elastic Market demand curve is the same as the firm's demand curve oP > MR P P Q TR MR $12 0 $0 10 1 10 $10 8 2 16 6 6 3 18 2 Demand 4 4 16 2 2 5 10 6 MR Q Monopoly Profit Rules for max profit are same for perfectly competitive firms and monopolies P MC P* D Q* MR Q Short run and long run o Perfectly competitive = short run economic profit becomes normal profit in the long run as firms enter marker o Monopoly = short run economic profit becomes long run economic profit because barriers to entry prevent other firms from entering Monopolies create a DWL o P monop > P erf. comp. M PC o Q > P Price discrimination selling at different prices Types 1. same unit to different people at different prices (ex: student discount) 2. different units at different prices (ex: 1st and 2nd ice cream scoop) Conditions 1. Two or more groups with different demands 2. firm must be able to identify groups 3. firm must be able to prevent resale of product Perfect price discrimination occurs if a firm can sell each unit of output for highest price someone is willing to pay for it Monopoly Reg
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