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ECO304K

TEST 2

QuestionAnswer
Price Ceiling a legally imposed maximum price
Price Floor a legally imposed minimum price
Price Controls price control, price floor
Price Floors must be HIGH
Price Ceilings must be LOW
Rent Control type of price ceiling
Rent Control (Price Ceilings) Consequences inefficient quantity: deadweight loss
Rent Control (Price Ceilings) Consequences inefficient allocation to consumers
Rent Control (Price Ceilings) Consequences applicant cannot compete on price
Rent Control (Price Ceilings) Consequences wasted resources searching
Rent Control (Price Ceilings) Consequences no incentive to maintain supply/quality of supply
Rent Control (Price Ceilings) Consequences black market
Price Floors the MINIMUM WAGE is a price floor. It is the lowest hourly wage rate that firms may legally pay their workers
The unintended consequence of a binding minimum wage is unemployment caused by: Decrease in quantity demanded for labor
The unintended consequence of a binding minimum wage is unemployment caused by: Increase in quantity supplied of labor
The unintended consequence of a binding minimum wage is unemployment caused by: Firms replacing low-skilled jobs with capital
The unintended consequence of a binding minimum wage is unemployment caused by: Firm relocation to states or countries with lower wages
The unintended consequence of a binding minimum wage is unemployment caused by: Shortening hours for workers
Price Controls attempt to set prices through government regulations in the market
Price Controls Enacted to ease perceived burdens on society
Price Ceiling a legally established maximum price for a good or service
Price Ceiling Create many unintended effects that policymakers rarely acknowledge
Law of Demand if the price drops, the quantity that consumers demand will increase
Law of Supply the quantity supplied will fall because producers will be receiving lower profits for their efforts
Shortage combination of increased quantity demanded and reduced quantity supplied
Effect of a Price Ceiling depends on the level at which it is set relative to the equilibrium price
Binding Price Ceiling stops prices from rising
Nonbinding Price Ceilings when a price ceiling is ABOVE the equilibrium price
Nonbinding Price Ceilings Occurs when the price ceiling DOES NOT influence the market
Nonbinding Price Ceilings A price ceiling that has NO effect
Equilibrium Price as long as the equilibrium price remains below the price ceiling, price will continue to be regulated by supply and demand
Binding Price Ceilings when a price ceiling is below the market price, it creates a binding constraint that prevents supply and demand from clearing the market
Binding Price Ceilings Occurs when the price is well below the equilibrium price
Binding Price Ceilings A price ceiling that FORCES the price to change
Binding Price Ceilings Creates a SHORTAGE in the short run, which gets LARGER in the long run
Rent Control a price ceiling that applies to the market for apartment rentals
Price Gouging Laws place a temporary ceiling on the prices that sellers can charge during times of emergency
Price Gouging Laws Serve as a nonbinding price ceiling during normal times
Price Floor a legally established minimum price for a good or service
Price Floor Result from the political pressure of suppliers to keep prices high
Minimum Wage Law example of a price floor in the market for labor
Binding Price Floor keeps prices from falling
Nonbinding Price Floors the price is below the equilibrium price
Nonbinding Price Floors Has no effect on the price of a good or service
As long as the equilibrium price remains above the price floor price is determined by supply and demand
Binding Price Floor set above the market equilibrium price
Binding Price Floor For a price floor to have an impact on the market, it must be set above the market equilibrium price
Binding Price Floor Quantity supplied will exceed the quantity demanded
Binding Price Floor Has an effect on the price of the good or service
Binding Price Floor Requires buyers to pay a higher price, which by the law of demand, causes them to decrease their quantity demanded. On the other hand, seller behave according ro the law of supply and desire to sell higher quantities now that the price is higher
Binding Price Floor creates a SURPLUS in the short run, which gets LARGER in the long run
Minimum Wage the lowest hourly wage rate that firms may legally pay their workers
Minimum Wage Functions as a price floor
Price Ceiling a legally imposed MAXIMUM price
Price Ceiling Must be LOW, below equilibrium
Price Ceiling rent control
Price Floor a legally imposed MINIMUM price
Price Floor Must be HIGH, above equilibrium
Rent Control (Price Ceilings) Consequences Inefficient Quantity: deadweight loss
Rent Control (Price Ceilings) Consequences Inefficient allocation to consumers
Rent Control (Price Ceilings) Consequences Applicants cannot compete on price
Rent Control (Price Ceilings) Consequences Wasted resources searching
Rent Control (Price Ceilings) Consequences No incentive to maintain supply/quality of supply
Rent Control (Price Ceilings) Consequences Black Market
When price falls and quantity rise WITHOUT a shortage no deadweight loss
Incentives to develop more housing increase supply
Price Floors the MINIMUM WAGE is a price floor
Price Floors Lowest hourly wage rate that firms may legally pay their workers
Unintended Consequence of a binding minimum wage is unemployment caused by Decrease in quantity demanded for labor
Unintended Consequence of a binding minimum wage is unemployment caused by Increase in quantity supplied of labor
Unintended Consequence of a binding minimum wage is unemployment caused by Firms replacing low-skilled jobs with capital
Unintended Consequence of a binding minimum wage is unemployment caused by Firm relocation to states or countries with lower wages
Unintended Consequence of a binding minimum wage is unemployment caused by Shorten hours for workers
Investing in capital to save labor cost
What does economic research say about the effect of minimum wage: Elasticity of -0.1 : 10% increase in the minimum wage reduces teen employment by 1%
Market Equilibrium the wage a worker is paid
Market Equilibrium Price market gets to without interference
Externalities When social benefits/costs differ from the private benefits/costs, externalities create a third-party problem
Market failure the market has not allocated resources efficiently-agents do not take into account the externality when deciding how much to produce and/or consume
Market failure Need to internalize the external cost to get to the efficient allocation
Correcting Negative Externalities Regulation
Correcting Negative Externalities Taxes
Correcting Negative Externalities Private Negotiation
Induced Demand providing more of a free resource will induce more demand to fill it
Induced Demand Example After the widening of the Katy Freeway, morning and evening travel times along the route increased by 30 and 55 percent
Dynamic Pricing allows the price to vary with supply and demand
dynamic pricing ride sharing, smart parking meters, toll lanes
Enhancing Positive Externalities Subsidies
Enhancing Positive Externalities Other incentives
Enhancing Positive Externalities Private Institutions
Subsidies encourages consumers to internalize the externality.
subsidies result consumption moves from the market equilibrium (QM) to a social optimum at a higher quantity (QS), use of public transportation increases, and the deadweight loss from insufficient market demand is eliminated
Three Types of Externalities negative externality, positive externality, negligible externality
negative externality market quantity is MORE than socially desirable
positive externality market quantity is LESS than socially desirable
negligible externality market quantity is CLOSE to socially desirable
Coase Theorem states that where there are no transactions costs, any externalities will be internalized, regardless of how property rights are divided.
Non-Rival one person enjoying the good does not keep others from enjoying it
Non-excludable once a resource is provided, even those who fail to pay for it cannot be excluded from enjoying its benefits
Four Types of Goods Private Good, Common Resource, Club Good, Public Good
Private Good excludable and rival
Club Good excludable and NOT rival
Common Resource NOT excludable, rival
Public Good NOT excludable, NOT rival
Example of Private Good personal sweatshirts, personal clothing
Example of Club Good gym membership
Example of Common Resource fishing in a pond (it is open to the public, but the number of fish is rival)
Example of Public Good public beach
Free-Rider someone who derives value from the public good without paying an efficient amount for its supply.
Free Rider No incentive to contribute - end up with under provision of the public good, below the efficient level.
Free Rider Example using someone else's wifi. I benefit from the amount that you are willing to pay to provide
Tragedy of Commons the tendency for a resource that has no price to be used until its marginal benefit = 0.
Optimal Amount of Pollution It is NOT zero
Optimal Amount of Pollution The optimal quantity of pollution occurs where MC = MB
MC marginal cost
MB marginal benefit
Externalities when social benefits/costs differ from the private benefits/cost
Externalities Creating a third-party problem often leading to undesirable consequences
Externality Example noisy neighbors
Market Failure occurs when there is an inefficient allocation of resources in a market
Externalities are a type of market failure
Two things that must occur for a market to work as efficiently as possible • Each participant must be able to evaluate the internal costs of participation • External costs must be paid
Internal Costs (BENEFIT) the costs of a market activity paid only by an individual participant
Internal Costs (BENEFIT) Example when we choose to drive somewhere, we typically consider out internal (also known as personal costs) such as the time it takes to reach a destination, amount paid for gas, routine vehicle maintenance
External Costs the costs of a market activity imposed on people who are not participants in that market
External Costs Congestion and pollution our cars create
Social Costs the sum of the internal costs and external costs of a market activity
Externality exists when an internal cost diverges from a social cost
Externality manufacturers who make vehicles and consumers who purchase them benefit from the transaction, but both making and using those vehicles lead to externalities (air pollution and traffic congestion – things that adversely affect others)
Third-Party Problem occurs when those not directly involved in a market activity experience negative or positive externalities
Adversely Affected Third Party externality is negative
Negative Externality present a challenge to society because it is difficult to make consumers and producers take responsibility for the full costs of their actions
Negative Externality the number of vehicles on the roads cause air pollution
Negative Externality Create challenges to society because it is difficult to make consumers and producers take full responsibility for their actions
Negative Externality Create challenges to society because it is difficult to make consumers and producers take full responsibility for their actions
Social Optimum price and quantity combination that would exist if there were no externalities
Internalize firms internalize an externality when they consider the external costs (or benefits) to society that occur as a result of their actions
Externality when an externality occurs, the market equilibrium creates a deadweight loss
Positive Externalities result of economic activities that have benefits for third parties
Positive Externalities Vaccines
Markets Do not handle externalities well
Negative Externality Market market produces too MUCH of a good
Positive Externality Market market produces too LITTLE of a good
Subsidy decreases the cost of production and encourages the firm to produce more
How could the government force a firm to internalize a negative externality associated with a good or service the firm produces? TAX THE PRODUCT
Tax one way to align the producer’s internal cost of production with the social cost of production when there is a negative externality
Property Rights give the owner the ability to exercise control over a resource
Property Rights When property rights are not clearly defined, resources can be mistreated
Property Rights Example because no one owns the air, manufacturing firms often emit pollutants into it
Private Property provides an exclusive right of ownership that allows for the use, and especially the exchange of property
Coase Theorem states that if there are no barriers to negotiations, and if property rights are fully specified, interested parties will bargain to correct externalities
Coase Theorem There are no transaction costs when you begin negotiating
Coase Theorem Negotiation to internalize
Coase Theorem Mutual agreement
Excludable Good one for which access can be limited to paying customers
Rival Good a good that cannot be enjoyed by more than one person at a time
Private Good excludable and rival in consumption
Private Good Example a sandwich is excludable because you must purchase it before you can eat it; but it is also a rival because only one person can eat it
In the absence of externalities excludability and rivalry allow the market to work efficiently
Public Good are consumed by more than one person, and nonpayers are difficult to exclude
Public Good Example fireworks
Public Good Example • Consumers cannot be easily forced to pay to observe fireworks, they may desire more of the good than is typically supplied. As a result, a market economy underproduces fireworks displays and many other public goods
Public Good 1) Consumer by more than one person 2) It is difficult to exclude nonpayers
Public Good often underproduced because people can get them without paying for them
Public Good Public Goods, like externalities, also result in market failure
Free-Rider Problem occurs whenever someone receives a benefit without having to pay for it
Club Good nonrival in consumption and excludable
Club Good Streaming Services are an example: Netflix, Hulu, Disney
Common-Resource Good rival in consumption and nonexcludable
Common-Resource Good Can be depleted and cannot be enjoyed by more than one consumer at a time
Common-Resource Good Access cannot be limited to paying customers (nonexcludable)
Common-Resource Good Example: air
Nonexcludable nonpayers are difficult to exclude (free riders can enjoy a fireworks display without paying)
Excludable a person can be restricted in use to paying customers
Cost-Benefit Analysis a process that economists use to determine whether the benefits of providing a public good outweigh the costs
Costs usually easier to quantify than benefits
Tragedy of the Commons occurs when a common-resource good becomes depleted
Tragedy of the Commons All externalities are market failures, but not all market failures are externalities.
Tragedy of the Commons The socially optimal equilibrium price is higher than the market equilibrium price.
Tragedy of the Commons The socially optimal quantity is less than the market equilibrium quantity
Dynamic Pricing the price varies with supply and demand
Enhancing Positive Externalities - Subsidies - Public Transport - Prive Institutions - Other Incentives
Coase Theorem states that there are no transaction costs, any externalities will be internalized, regardless of how property rights are divided
Tragedy of the Commons -Public Good that is unmanaged by another, NO ONE has the incentive to take care of it - Social Norms dictate response
Excludable YOU HAVE TO PAY FOR IT TO GET IT
Excludable Example using the tollway
Non-Excludable you can still get it even if you don’t pay for it (example: using the highway)
Total Fixed Costs are CONSTANT no matter how much is produced
Total Variable Costs RISE with production
Calculation for Total Cost Total Fixed Cost + Total Variable Cost
Calculation for Average Fixed Cost Total Fixed Cost / Quantity
Calculation for Average Variable Cost Total Variable Cost / Quantity
Calculation for Average Total Cost Total Cost / Question
Marginal Cost change in total cost / change in quantity
Profit (or loss) total revenue - total cost
Accounting Profit total revenue - the EXPLICIT costs of business
Economic Profit total revenue - total cost of doing business (both explicit and implicit).
Total FIXED cost CONSTANT no matter how much is produced
Total VARIABLE costs RISE with production
Q = ƒ(K,L) Q = output/time period K = capital inputs L = labor inputs
Marginals Leader Averages THINK GPA
Long Run Efficiency The long-run the cost of providing additional output is known as scale
Scale has nothing to do with diminishing marginal product.
Total Revenue amount a firm receives from the sale of goods and services
Total Revenue Example Total Revenue of McDonald’s is determined by the number of items sold and their prices
Calculating Profit and Loss calculate the difference between revenue and expenses (costs)
Total Cost the amount a firm spends to produce and/or sell goods and services
Determining the Total Cost the firm adds the individual costs of the resources use in producing and/or selling the goods
Profit occurs whenever the total revenue is HIGHER than the total cost 
Loss occurs whenever total revenue is LESS than total cost
Profit (or Loss) total revenue – total cost 
Explicit Costs tangible out-of-pocket expenses
Calculate Explicit Cost add every expense incurred to run the business
Calculate Explicit Cost Example the weekly supply of hamburger patties is one explicit cost; the owner receives a bill from the meat supplier and must pay it
Implicit Costs are the costs of resources already owned, for which no out-of-pocket payment is made 
Implicit Costs Also, opportunity costs, because the use of owned resources means that the next best opportunity is forgone
Implicit Costs Hard to calculate and easy to miss
Implicit Costs Example difficult to determine how much an investor could have earned from an alternative activity
Examples of a Firm’s Explicit Cost The Electricity Bill
Examples of a Firm’s Implicit Cost The labor of an owner who works for the company but does not draw a salary - includes the opportunity cost of the owner’s labor
Total Cost explicit costs + implicit costs 
Total Cost Example: Jane buys $30 in materials Jane takes half a day off from work, where she earns $12/hr After 4 hours, she completes the bookcase Explicit Cost= $30 (the cost of the materials to build the bookcase) Implicit Cost= $48 (the amount of money she gave up taking off work/ opportunity cost) Jane’s Total Cost= $78 (explicit + implicit)
Accounting Profit calculate by subtracting the explicit costs from total revenue
Accounting Profit Accounting figures permeate company reports, quarterly and annual statements, and the media
Accounting Profit DOES NOT consider the implicit costs of doing business
Accounting Profit Calculation accounting profit = total revenues – explicit costs
Economic Profit calculated by subtracting both the explicit costs and the implicit costs from total revenue
Economic Profit gives a more complete assessment of how a firm is doing 
Economic Profit Calculation economic profit = total revenues - (explicit costs + implicit costs) OR economic profit = accounting profit – implicit costs
If a business has an economic profit its revenues are larger than the combination of its explicit costs and implicit costs 
Economic Profit can be negative, since the negative dollar amount is a loss 
Output the product the firm creates 
Output A firm should produce an output that the consistent with the largest possible economic profit
Output A firm must also control its costs by using resources efficiently
Three Primary Factors of Production labor, land and capital
Factors of Production the inputs (labor, land, and capital) used in producing goods and services
Labor consists of workers Example: managers, cooks, cashiers, managerial staff
Land consists of the geographical location used in production Example: the land in which the business sits
Capital consists of all the resources the workers use to create the final product Example: the building itself, the equipment used, the parking lot, the signs, the hamburger patties, buns, fries, ketchup, etc.
Production Function describes the relationship between the inputs a firm uses and the output it creates
Specialization and Comparative Advantage lead to higher levels of output
Marginal Product the change in output associated with one additional unit of an input
Marginal Output Calculation (output from n input units) - (output from n- 1 input units)
Diminishing Marginal Product occurs when successive increases in inputs are associated with a slower rise in output 
Diminishing Marginal Product Diminishing does not mean negative
Costs in the Short Run all firms experience some costs that are unavoidable in the short run
Costs in the Short Run Example: a lease on a space or a contract with a supplier Costs can be variable or fixed
Variable Costs change with the rate of output
Variable Costs Example: if McDonalds only produces Big Macs, the variable costs are the workers, electricity, cleaning supplies and food supplies These are variable costs because the restaurant doesn’t NEED them UNLESS it has customers
The firm should not necessarily stop producing additional units If marginal product is still high, the firm should continue production if it can sell the output for more than the input costs.
As output expands a firm’s total fixed costs are spread over more units, thus decreasing the average fixed costs.
In the long run all costs are variable and firms have more control over their costs. In the short run, costs are related to diminishing marginal product. In the long run, costs are related to scale
Variable Costs ARE CONSUMEABLE 
Variable Costs Costs that change with the amount of output are variable
Fixed Costs DO NOT vary with output in the short run UNAVOIDABLE Also known as overhead
Fixed Cost Example: no matter how many Big Macs McDonalds sells, most of the costs associated with the building remain the same and the business must pay for them Rent, Insurance, Property Taxes
Average Variable Cost (AVC): is determined by dividing total variable cost by the output AVC = TVC / Q
Average Fixed Cost (AFC) determined by dividing total fixed cost by the output AFC = TFC / Q
Total Fixed Cost CONSTANT As the output rises, the average fixed cost declines
Average Total Cost (ATC) the sum of average variable cost and average fixed cost Calculated by adding the AVC and AFC OR dividing total cost by quantity (TC / Q)
Total Cost (TC) Curve equal to the sum of the total fixed cost and total variable cost curves
Total Fixed Cost (TFC) is constant THE TOTAL VARIABLE COST gives the TC curve its shape
Total Variable Cost (TVC) dictates the shape of the total cost curve
Marginal Cost (MC) the increase in cost that occurs from producing one additional unit of output (Cost of producing n units) - (cost of producing n – 1 units) EXTRA COST Always leads (or pulls) average variable cost and average total cost along
AFC ALWAY DECLINES as output rises
Short Run businesses have FIXED cost and FIXED capacities
Long Run ALL costs are VARIABLE and can be renegotiated Firms have more control over their costs in the long run, which enables them to reach their desired level of production
Scale refers to the size of the production process One-way firms can adjust in the long run
Efficient Scale the output level that minimizes average total cost in the long run
Diminishing Marginal Product no longer relevant in the long run
Short-Run reflection of diminishing marginal product
Long-Run reflection of scale and the cost of providing additional output
Three Types of Scale Economies of scale Diseconomies of scale Constant returns to scale
Economies of Scale occurs when long-run average total costs decline as output expands
Economies of Scale Examples Example: National homebuilders, such as Toll Brothers All builders do the same thing; however big companies can afford more equipment in bulk and manufacture the same homes as local builders at lower costs
Diseconomies of Scale occurs when the long-run average total costs rise as output expands Especially relevant in the service sector of the economy
Constant Returns to Scale occurs when the long-run average total costs remain constant as output expands
Constant Returns to Scale Example Example: constant returns to scale in big chain restaurants (such as Panda Express) means that a small local Chinese restaurant will have approximately the same menu prices
Long-Run Average Total Cost Curve (LRATC) a composite of many short-run average total cost curves (SRATC) At first, each LRATC curve exhibits economies of scale because of increased specialization, the utilization of mass production, bulk purchasing power, and increased automation
Long Run Possibilities economies of scale, constant returns to scale, diseconomies of scale
Most Efficient Output always the largest output 
Constant Returns to Scale the cost curve flattens out Once the curve becomes constant, firms of varying sizes can compete equally with one another because they have the same costs
Fixed Costs unavoidable and DO NOT vary with the output in the short run
Economic profit is calculated by subtracting both the explicit and the implicit costs from the total revenue
Accounting profit is calculated by subtracting the explicit costs from the total revenue
Economic profit ALWAYS LESS than accounting profit, because it considers implicit costs as part of the total cost
Firms in Competitive Markets have very little or no pricing powe
Firms in imperfect markets have significant pricing power.
Traits of Competitive Markets 1. Each firm sells similar (if not identical) goods. 2. There are many buyers and sellers. 3. Firms may enter or exit the market freely. 4. Every firm is a price taker, since they have little or no pricing power.
profit maximizing rule expand output until marginal revenue (MR) is just equal to marginal cost (MC)
MR > MC MORE profit
MR=MC MAXIMUM profit
Profit Maximizing Rule rule for STOPPING production
The overall market sets the price for firms (at market equilibrium price) – each firm then produces where P=MC=MR
market - firms earning a profit because P=MC above ATC
Would you continue to produce if you were losing money? In the short run: • Yes, if operating minimizes the loss. • No, if shutting down minimizes the loss
Would you continue to produce if you were losing money? In the long run: • No, you should go out of business.
Operate and make a profit: If demand is higher than the ATC curve
Operate to minimize loss If demand is below the ATC curve but above the AVC
Shut down If demand is below the AVC curve
Sunk Costs a cost that has already been committed and cannot be recovered • costs that have been incurred as a result of past decisions
Economists believe you should not make decisions based on sunk costs cannot change them
In the zero-profit equilibrium • firms earn enough revenue to exactly cover these costs • I.e. firm’s revenue must compensate for the owners for all opportunity costs • accounting profit is positiv
Market Structure how individual firms are interconnected
Competitive Markets exist when there are so many buyers and sellers that each one has only a small impact on the market price and output
Price Taker has no control over the price set by the market
Price Taker “takes” (accepts) the price determined from the overall supply and demand conditions that regulate the market
Price Taker Firms that produce goods in competitive markets
Price Taker Each seller is small compared to the overall market
Price Taker The individual seller's decision (to either increase or decrease production) has no impact on the market price
Characteristics of Competitive Markets: Many sellers Similar products Free entry and exit Price taking Every firm is small
Examples of Almost Perfect Markets: Stock Market Farmers’ Markets Online Ticket Auctions Currency Trading
Marginal Revenue the change in total revenue a firm receives when it produces one additional unit of output
Profit-Maximizing Rule states that profit maximization occurs when a firm chooses the quantity of output that equates marginal revenue and marginal cost, or MR = MC
Profit-Maximizing Rule The profit maximization occurs when a firm expands output as long as marginal revenue is greater than marginal cost
MR=MC Rule production should stop at the point at which profit opportunities no longer exist
Firm in a highly competitive market price taker
When marginal cost is higher than the marginal revenue the firms profit FALL
Profit (price – ATC [along the dashed line at quantity Q]) x Q)
Fixed Cost paid whether the business is open or not
Variable Costs incurred only when the business is open, if it can make enough to cover its variable costs
Economic Profit P > ATC (Price is greater than the average total cost of production)
Economic Loss P < ATC (price is less than the average variable cost of production)
ATC > P > AVC the average total cost of production is greater than the price the firm charges, but the price is greater than the average variable cost of production
ATC > P > AVC The firm will operate to minimize loss
Short Run the firm has only two options – produce at MC=MR or shut down
Sunk Costs uncoverable costs that have been incurred as a result of past decisions Money that has already been spent, no matter what comes next, and should have no bearing on future decisions
MR = MC firm maximizes profit when
Signals of profits and losses convey information about the profitability of various markets
Long Run The best the competitive firm can do is earn zero economic profit 
What characteristics causes firms in competitive markets to earn zero economic profit in the long run? easy entry and exit 
Horizontal Line P= minimum ATC
During a short-run period where market supply is adjusting to decreased market demand individual firms that choose to remain in the market will operate at a loss because price, and therefore marginal revenue, is less than average total cost.
When firms earn positive profits in a competitive market it means that P > ATC. This entices other firms to enter the market, causing the supply curve to shift rightward. At the new equilibrium, the price is driven down and the quantity increases. For firms in the market this results in decreased profits.
In the short run, some costs are fixed and the rest are variable. A firm will continue production only so long as it can cover at least its variable costs. production will only occur when price. marginal revenue, equals or exceeds average variable cost. Where that condition is met, the marginal cost curve becomes the short-run supply curve, because it is only along this line that marginal cost equals marginal revenue
In the simplest kind of case, the long-run market supply curve is perfectly horizontal However, more realistically it may slope upward, if increasing the quantity supplied leads to increased production costs, due to shortages in either material or labor.
Monopoly A monopoly has three main characteristics: 1. produces in a market with high barriers to entry 2. many buyers but only one seller 3. a unique product with no good substitutes
High Barriers to Entry A natural monopoly occurs when a single large firm has lower costs than any potential competitor.
High Barriers to Entry Control over an essential resource
High Barriers to Entry Raising enough capital: Lenders are not likely to loan you $10+ million to start a business. You need a big loan to compete with an established monopoly that already has a huge amount of capital and equipment invested.
High Barriers to Entry Government Restrictions
Perfect Competitor Price Taker, HORIZTONAL DEMAND CURVE
Perfect Competition exists when one firm’s output is irrelevant
Monopolist PRICE MAKER, Pure monopoly exists when one firm is the industry
What happens to MR when the firm lowers the price? The firm must consider the gains in revenue from additional sales (the “output” effect) versus the losses in revenue (the “price” effect).
Firm makes profit in the rectangles between P and ATC
Defects of Monopoly A reduction in the competitiveness of a market limits the options available to consumers.
Defects of Monopoly The signaling mechanism, which would ordinarily encourage competition and eliminate excessive profits, is broken since the monopolist enjoys high barriers to entry.
Defects of Monopoly Prices are higher and output is lower than under perfect competition.
The Defects of Monopoly Prices are higher and output is lower than under perfect competition
Defects of Monopoly Firm often engage in rent seeking, which is an unhealthy competition to become a monopolist.
Solutions to Monopoly 1. Break up the monopoly 2. Reduce barriers to entry 3. Regulate the market 4. Do nothing
Monopolists enjoy market power for their specific product
Monopolists Cannot force consumers to purchase what they are selling A firm that controls a monopoly market
Law of Demand when a monopolist charges more, people buy less If demand is low enough, a monopolist may even experience a LOSS instead of PROFIT When demand is HIGH, and on top of that is INELASTIC, a monopolist is sometimes able to earn massive profits
Monopolies sometimes hold the power between life and death
Examples of Monopolies NFL and small-town businesses
Monopolies A local electric company is a monopoly A monopolist can lose money Monopolists must keep their prices low enough that some customers can buy their products
Monopolies Monopolists CANNOT make a profit by charging any price they want A monopolist DOES NOT always make a profit Walmart IS NOT a monopoly
Monopoly exists when a single seller supplies the entire market for a particular good or service
Two conditions that enable a single seller to become a monopolist: The firm must have something unique to sell (without close substitutes) It must have a way to prevent potential competitors from entering the market
Examples of monopolies Companies that provide natural gas, water and electricity are all examples of monopolies that occur naturally because of economies of scale
Examples of monopolies Monopolies can occur when the government regulates the amount of competition (trash pickup, street vending, taxicab rides, and ferry services)
Monopoly Power: a measure of a monopolist's ability to set the price of a good or service
Barriers to Service restrictions that make it difficult for new firms to enter the market
Barriers to Service Monopolists have no competition nor any immediate threat of competition Insulates the monopolist from competition, which means that many monopolists enjoy LONG-RUN economic profits
Natural Barriers exist naturally within the market Control of resources, problems in raising capital and economies of scale
Control of Resources the best way to limit competition is to control a resource that is essential in the production process
Control of Resources: Extremely effective barrier to entry BUT hard to accomplish If you control a scarce resource, other competitors will not be able to find enough of it to compete
Monopolists usually very big companies that have grown over an extended period Raising capital to compete effectively is difficult
Economies of Scale occur when long-run average costs fall as production expands Low unit costs and the low prices that follow give some larger firms the ability to drive rivals out of business
As the firm expands in an industry that enjoys large economies of scale, production costs per unit continue to FALL (firms in the industry tend to combine over time)
Natural Monopoly occurs when a single large firm has lower costs than any potential smaller competitor Example: merging of companies over time (as firm expands and production costs per unit continue to fall)
Creation of a Monopoly can be either intentional or an unintended consequence of a government policy Government-enforced statues and regulations, such as laws and regulations covering licenses and patents, limit the scope of competition by creating barriers to entry
Minimize Negative Externalities governments occasionally establish monopolies, or near monopolies, through licensing requirements Example: in some communities, trash collection is licensed to a single company
Licensing also creates an opportunity for corruption In some places in the world, bribery is so common that it often determines which companies receive licenses in the first place
Licensing Example: because firms cannot collect trash without a government-issued operating license, opportunities to enter the business are limited
Monopolies the government creates monopolies by granting patents and copyrights to developers and inventors
Monopolies Patents and copyrights create stronger incentives to develop new drugs and produce new music than would exist if market competitors could immediately copy inventions
Characteristics of Monopolies: One seller A unique product without close substitutes High barriers to entry Price making
Monopolist SOLE provider of its product and holds market power Monopolists are PRICE MAKERS
Price Maker has some control over the price it charges Monopolists are price makers
Price Taker firms in competitive markets
Competitive Market the demand curve for the product of a firm in a competitive market is HORIZONTAL
Price Takers when individual firms are price takers, they have NO CONTROL over what they charge Demand is PERFECTLY ELASTIC OR HORIZONTAL because every firm sells the same product
Price Takers Demand for an individual firm’s product only exists at the price determined by the market Each firm is such a small part of the market that it can sell its entire output without lowering the price
Monopolist ONLY firm – the sole provider in the industry The demand curve for its product is DOWNWARD SLOPING which limits the monopolist's ability to make a profit
Monopolist Monopolists would like to exploit its market power by charging a high price to many customers Downward Sloping Demand curve of monopolists has many price-output combinations
If market demand is inelastic a monopolist will choose a higher price
When the market demand is more elastic a monopolist will choose a lower price
Monopolists must search for the profit-maximizing price and output
Monopolist because of the downward-sloping demand curve, must search for the most profitable price
Profit-Maximizing Rule MR=MC
Price Taking Firm MR is the market price
Total Revenue Calculation TR = Q x P (quantity x price)
Triangle change
Price Effect reflects how the lower price affects revenue Example: if the price of service drops from $70 to $60, each of the 3,000 existing customers saves $10, and the firm loses 10 x 3,000 or $30,000 in revenue represented by the red area on the graph
Output Effect reflects how the lower price affects the number of customers Example: because 1,000 new customers buy the product when the price drops to $60, revenue increases by $60 x 1,000 or $60,000, represented by the green area
Lost Revenues Associated with the price effect are always subtracted from the revenue gains created by the output effect
High Price Levels Demand is ELASTIC The price effect is small relative to the output effect As the price drops, demand slowly becomes more inelastic (output effect diminishes and the price effect increases)
High Price Levels As the price falls, it becomes harder for the firm to acquire enough new customers to make up for the difference in lost revenue (price effect becomes larger than the output effect)
Negative Marginal revenue the firm CANNOT maximize profit Puts an upper limit on the amount the firm will produce Once the price becomes too low, the firm’s marginal revenue is negative
Less Competitive Market Marginal revenue is ALWAYS LESS than the price
Monopolist marginal revenue should be equal to marginal cost DOES NOT charge a price equal to marginal revenue
MR=MC the point at which a firm will maximize its profits
Profit Maximizing Output Q (quantity)
Competitive Firm must take the price established in the market If it does not operate efficiently, it cannot survive nor can it make an economic profit in the long run
Monopolies because high barriers to entry limit competition, the monopolist may be able to earn long-run profits by restricting output Operates inefficiently from societies perspective, and it has significant market power
Monopolies Market demand = demand for the monopolist Marginal Revenue falls below demand Marginal Revenue: revenue from one more unit Demand= average revenue
Monopolies If monopolist wants to sell more, they must drop the price Produces less than the efficient level of output (because P>MC) May earn long-run economic profits
What is the relationship between marginal revenue and price for a monopolist? Answer: MR < P
Monopolist maximizes its profits by charging a price equal to the height of the demand curve at the profit-maximizing quantity
Monopolies can adversely affect society by restricting output and charging higher prices than sellers in competitive markets do
Monopolies Causes monopolies to operate inefficiently, provide less choice, promote an unhealthy form of competition known as rent seeking, and make economic profits that fail to guide resources to their highest- valued use
Market Failure occurs when there is an inefficient allocation of resources in market
Monopolists charge too much and produces too little Supply curve becomes the monopolist's marginal curve
Smaller Output than the competitive industry (QM < QC NOT EFFICENT
Higher Price (PM > PC)
perfectly competitive firms Easy entry and exit into the market mean that, in the long run, all perfectly competitive firms should expect to earn zero profits.
The firms's long-run supply curve begins where price is above average total cost
) The firm's short-run supply curve begins where price is above average variable cost
The long-run supply curve is flat.
In a competitive market the long-run price is the minimum average total cost for the typical individual firm in the market,
The number of firms in the market stabilizes when the typical firms make zero economic profit.
As the number of firms changes, so does the market supply curve This leads prices to increase in the market.
Any impact of this change will disappear in the long run.
If the firm has economies of scale it is a natural monopoly.
price effect is equal to the number of original customers times the change in price.
the output effect is the new price times the number of new customers.
example of output effect The output effect reflects how the change in price impacts revenue due to the change in the number of customers. By decreasing price by $20, the ISP will now serve 4 thousand more customers. $90 × 4 thousand = $360 thousand.
The price effect reflects how a change in price effects revenue, holding the number of customers fixed at the initial amount EXAMPLE . When the ISP charged $110, it served 8 thousand customers. If it decreases the price by $20, the price effect is equal to –$20 × 8 thousand= –$160 thousand.
If demand for a monopolist’s product falls price decreases , quantity decreases , and profit decreases
TRUE A monopolist can earn profits in the long run, but a firm in a perfectly competitive market cannot.
Monopoly Produces where P>MC
The problem associated with marginal cost pricing in a natural monopoly is negative economic profit.
The supply will increase, and the demand will decrease. Therefore, we know price will decrease, but we cannot be sure what happens to quantity.
it is nonbinding there will be no changes to the market equilibrium price and quantity
If an effective price ceiling is implemented in a market what is likely to happen to the opportunity cost of finding the good The opportunity cost will rise
price ceiling is set above the equilibrium price. This will result in a nothing
of a new binding price ceiling is passed, what impact will this have on the amount of discrimination in society discrimination will increase
state & national wages are non-binding
Zero economic profits is the same thing as a positive accounting profit
which of these is an implicit cost capital invested in the business
output is a function of labor and capital
if a firm is producing where MC is sloping downwards and MC is below the AVC then ATC is decreasing
The ATC always lies above the AVC
economic profit total revenues - (explicit costs + implicit costs)
if your revenue while producing is greater than your variable cost you should operate in the short run
Your business currently charges the profit-maximizing price, but you are making a loss. Which of the following should you do? shut down if your price is less than your average variable cost
when the perfectly competitive firm is at its breakeven point in the long run, which of the following is true it is operating at the lowest point on its ATC curve
In perfect competition, if the price of the good is higher than the AVC, but lower than the ATC, and the business environment is optimistic, then a firm will operate in the short run
demand curve for a perfectly competitive firm is perfectly elastic
f a perfectly competitive firm is producing an output rate at which marginal cost is greater than price, the firm should reduce its output level
the MR curve for a price taker is HORIZONTAL
Profit maximizing output is where P*= MC
the breakeven point is the minimum of the ATC curce
the shutdown point is the minimum of the AVC curve
if price is above the minimum of the ATC curve the firm is making positive profits
Which of the following is true about a monopolist MR curve? The MR curve lies below the demand curve because the monopolist faces a downward sloping market demand curve
Which of the following is NOT an essential characteristic of a monopoly? The monopolist makes an economic profit
Which of following is NOT a cost of monopoly? The monopolist produces too much output compared to perfect competition
Which of the following is the best example of rent seeking? politicians competing to win an election
name three barriers to entry control over a natural resource, economies of scale, legal barriers
Efficiency in production occurs at the lowest point on ATC curve
Created by: sydg10
 

 



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