246 terms
AP Micro Economics AP Exam
Flashcards for AP Microeconomics midterm; I got the terms from my own personal textbook for the AP Micro/Macro exams called 5 steps to a 5. I highly recommend this book for the AP exam in the spring.
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Terms in this set (...)
Economics
The study of how people, firms, and societies use their scarce productive resources to best satisfy their unlimited wants
Factors of Production
Labor, Land, Capital, Entrepreneurial ability
Labor
Human effort and talent, physical and mental. This can be augmented by education and training (human capital)
Land or Natural Resources
Any resource created by nature. This may be arable land, mineral deposits, oil and gas reserves, or water
Physical capital
Manmade equipment like machinery, but also buildings, roads, vehicles, and computers
Entrepreneurial Ability
The effort and know how to put the other resources (Factors of Production) together in a productive venture
Scarcity
The difference between unlimited wants and limited economic resources
Trade-offs
The fact that we are faced with scarce resources implies that individuals, firms, and governments are constantly faced with trade-offs
Opportunity Cost
The opportunity cost of doing something is what you sacrifice to do it (i.e. if you use a scarce resource to pursue activity X, the opportunity cost of activity X is activity Y, the next best use of that resource)
Marginal Analysis
Rational individuals and firms weigh the additional benefits against the additional costs (They think at the margin)
Marginal
"the next one" or "additional" or "incremental"
Marginal Cost
The additional cost incurred from the consumption of the next unit of a good or service
Marginal Benefit
The additional benefit received from the consumption of the next unit of a good or service
Marginal Decision Making
Do something if the marginal benefit is greater than or equal to the marginal cost of doing it
Stop doing something when the marginal benefit is equal to the marginal cost of doing it
Never do something when the marginal benefits are less than the marginal cost of doing it
Stop doing something when the marginal benefit is equal to the marginal cost of doing it
Never do something when the marginal benefits are less than the marginal cost of doing it
Production Possibilities Curve
A model of an individual or a nation that can choose to allocate its scarce resources between the production of two goods or services, it is assumed that those resources are being fully employed and used efficiently
Points on the Production Possibilities Curve
Each point on the curve represents some maximum output combination of the two products
Points outside of the Production Possibilities Curve
Any point outside the frontier is currently unattainable
Points inside the Production Possibilities Curve
Any point inside the frontier fails to use all of the individual/nations available resources in an efficient way
The PPF in the long run
Over the course of time the PPF is believed to expand
The slope of the PPF
The slope of the curve measures the opportunity cost of the good on the x axis
The inverse of the slope measures the opportunity cost of the good on the y axis
The inverse of the slope measures the opportunity cost of the good on the y axis
Resource Substitutability
Because resources used to produce good X are not necessarily suitable for the production of good Y the PPF is bow shaped (it is unrealistic for it to be linear)
Law of Increasing Costs
The more goods that are produced, the greater its opportunity cost
Shape of a realistic PPF
Concave or bowed outward
Absolute Advantage
The ability to produce more of a certain good than another individual/firm/nation
Comparative Advantage
The ability to produce goods at a lower opportunity cost that another individual/firm/nation
Specialization
Individuals/firms/nations produce the goods in which they have a comparative advantage
Benefits of Specialization
Goods are produced at a lower cost
Individuals/firms/nations attain greater profits
Consumers benefit from lower prices
Individuals/firms/nations attain greater profits
Consumers benefit from lower prices
Productive efficiency
The economy is producing the maximum output for a given level of technology and resources (all points on the PPF are productively efficient)
Allocative efficiency
The economy is producing the optimal mix of goods and services (the combination of goods and services that provides the most net benefit to society; the best point on the PPF)
Allocative efficiency on the PPF
The point on the PPF were the economy is allocatively efficient is were the marginal benefit of consuming a goods is equal to the marginal cost of producing it
Economic Growth
The ability to produce a larger total output over time, can occur ia one or all of the following occur
-An increase in the quantity of resources
-An increase in the quality of existing resources
-Technological advancements in production
-An increase in the quantity of resources
-An increase in the quality of existing resources
-Technological advancements in production
Keys to a Market System
Private Property
Freedom
Self-interest and incentives
Competition
Prices
Freedom
Self-interest and incentives
Competition
Prices
Private Property
Individuals, not governments, own most economic resources. This private ownership encourages innovation, investment, growth, and trade
Freedom
Individuals are free to acquire resources to produce goods and services, and free to chose which of their resources to sell to others so that they may buy their own goods and services
Self-Interest and Incentives
Individuals are motivated by their own self-interest in their use of resources. Entrepreneurs seek to maximize profit while consumers seek to maximize happiness; with these incentives, goods are sold an bought
Competition
Buyers and sellers, acting independently, and motivated by self-interest, freely move in and out of individual markets. Again, the issue of incentives is powerful. A new firm, eager to compete in a market, only enters that market if profits are available
Prices
Prices send signals to buyers and sellers, and resources allocation decisions are mad based upon this information. Prices also serve to ration goods to those consumers who are most able to pay those prices
Law of Demand
Holding all else equal (ceteris paribus), when the price of a good rises, consumers decrease their quantity demanded for that good (there is an inverse relationship between the price and the quantity demand of a good)
Nominal vs. Real prices
Nominal prices measure the price of a good in units of currency while real prices measure prices in terms of another good one must give up to buy that good (The number of units of any good Y that must be sacrificed to acquire the first good X) ONLY RELATIVE PRICES MATTER
Substitution effect
The change in quantity demanded resulting from a change in the price of one good relative to the price of other goods
Income effect
The change in quantity demanded resulting from a change in the consumer purchasing power (real income)
Demand schedule
A table showing quantity demanded for a good at various prices
Demand curve
A graphical representation of the demand schedule; the demand curve is downward sloping, reflecting the law of demand
Quantity Demand vs. Demand
If the price of a good changes and all other factors remain constant, the demand curve is held constant and we simply observe the consumer moving along the fixed demand curve. If one of the external factors change, the entire demand curve shifts left or right
Determinants of Demand
-Consumer income
-The price of a substitute good
-The price of a complimentary good
-Consumer tastes and preferences for the good
-Consumer expectations about the future price of the good
-The number of buyers in the market for that specific good
-The price of a substitute good
-The price of a complimentary good
-Consumer tastes and preferences for the good
-Consumer expectations about the future price of the good
-The number of buyers in the market for that specific good
Consumer income
For normal goods increased income results in a rightward shift in the demand curve (increased demand) and decreased income results in a leftward shift in the demand curve
*Inferior goods act the opposite way*
*Inferior goods act the opposite way*
Normal Good
A good for which higher income increases demand
Inferior Good
A good for which higher income decreases demand
Price of Substitute Goods
If two goods are substitutes, and the price of good x falls (rises), the consumer demand for good Y decreases (increases)
Substitute Goods
Two goods are substitute goods if the consumer can use either to satisfy the same essential function, therefore experiencing the same degree of happiness (utility)
Price of Complementary Goods
If any two goods are compliments and the price of one good X falls (rises), the consumer demand for the complement good Y increases (decreases)
Tastes and Preferences
A stronger (lower) preference for a good is an increase (decrease) in the willingness to pay for the good, which increases (decreases) demand
Future Expectations
The future expectation of a price change or an income change can cause demand to shift today. Demand can also respond to an expectation of the future availability of a good
Number of Buyers
An increase in the number of buyers, holding all factors constant, increases the demand for a good
The Law of Supply
Holding all else equal, when the price of a good rises, suppliers increase their quantity supplied for that good (there is a direct relationship between the price and the quantity supplied of a good
Increasing marginal costs
As more of a good is produced, the greater its marginal cost
-As suppliers increase the quantity supplied of a good, they face rising marginal cost
-Suppliers only increase the quantity supplied of a good if the price received is high enough to at least cover the higher marginal cost
-As suppliers increase the quantity supplied of a good, they face rising marginal cost
-Suppliers only increase the quantity supplied of a good if the price received is high enough to at least cover the higher marginal cost
Supply Schedule
A table showing quantity supplied for a good at various prices
Supply Curve
A graphical representation of the supply schedule. The supply is upward sloping, reflecting the law of supply
Quantity Supplied vs. Supply
When the price of a good changes, and all other factors are held constant, the supply curve is held constant; we simply observe the producer moving along the fixed supply curve. If one of the external factors change, the entire supply curve shifts to the left or right
Determinants of Supply
-The cost of an input
-Technology and productivity
-Taxes and subsidies on a good
-Producer expectations about future prices
-The price of other goods that could be produced
-The number of producers in the industry
-Technology and productivity
-Taxes and subsidies on a good
-Producer expectations about future prices
-The price of other goods that could be produced
-The number of producers in the industry
Cost of Inputs
If the cost of inputs fall (rises) producers will increase (decrease) supple thereby shifting the supply curve to the right (left)
Technology or Productivity
A technological improvement (reduction) usually decreases (increases) the marginal cost of producing a good, thus allowing the producer to supply more (less) units, which is reflected by a rightward (leftward) shift in the supply curve
Taxes and Subsidies
A per unit tax is treated by firms as an additional cost of production and would therefore decrease the supply cure, or shift it leftward
A per unit subsidy lowers the per unit cost of production and therefore shifts the supply curve rightward
A per unit subsidy lowers the per unit cost of production and therefore shifts the supply curve rightward
Price expectations
A producers willingness to supply today might be affected by an expectation of tomorrows price
Price of Other Outputs
Firms can use the same resources to produce different goods. If the price of good X were rising and profit opportunities were improving for good X producers, the supply of good Y would decrease as the supply of good x increased
Number of Suppliers
When more supplier enter a market, we expect the supply curve to shift right. If suppliers left the market the supply curve would shift left
Market Equilibrium
The market is in a state of equilibrium when the quantity supplied equals the quantity demanded at a given price
Shortage
A shortage exists at a market price when the quantity demanded exceeds the quantity supplied
Surplus
A surplus exists at a market price when the quantity supplied exceeds the quantity demanded
Changes in Demand
When demand increases, equilibrium price and quantity both increase
When demand decrease, equilibrium price and quantity both decrease
When demand decrease, equilibrium price and quantity both decrease
Changes in Supply
When supply increases, equilibrium price decreases and quantity increases
When supply decreases, equilibrium price increases and quantity decreases
When supply decreases, equilibrium price increases and quantity decreases
Simultaneous Changes in Demand and Supply
When both demand and supply are changing, one of the equilibrium outcomes (price or quantity) is predictable and one is ambiguous
Total Welfare
The sum of consumer and producer surplus
Consumer Surplus
The difference between your willingness to pay and the price you actually pay
Producer Surplus
The difference between the price received and the marginal cost of producing the good
Consumer Surplus on the Graph
The area under the demand curve and above the market price is equal to total consumer surplus
Producer Surplus on the Graph
The area above the supply curve and below the market price is equal to total producer surplus
Elasticity
Measures the sensitivity, or responsiveness, of a choice to a change in an external factor
Price Elasticity of Demand
Measures the sensitivity of consumer quantity demanded for good X when the price of good X changes
Price Elasticity Formula
Ed= (%change in quantity demanded of good X)/(%change in the price of good X)
A good is price elastic if...
If Ed > 1
A good is unit price elastic if...
If Ed = 1
A good is price inelastic if...
If Ed < 1
Elasticity on the Demand Curve
Above the midpoint demand is price elastic
At the midpoint demand is unit elastic
Below the midpoint the demand is price inelastic
At the midpoint demand is unit elastic
Below the midpoint the demand is price inelastic
Delta Percentage
Delta Percentage = [final cost - initial cost]/initial cost
Perfectly Inelastic
Any increase in the price results in no decrease in the quantity demanded
Perfectly Elastic
A decrease in the price causes the quantity demanded to increase without limits
As the demand curve becomes more vertical
The price elasticity falls and consumers become more price inelastic
As the demand curve becomes more horizontal
The price elasticity increases and consumers become more price elastic
Determinants of Elasticity
-Number of Good Substitutes
-Proportion of Income
-Time
-Proportion of Income
-Time
Number of Good Substitutes
If the price of good X increase, and many (few) substitutes exist, the decrease in quantity demanded can be quite elastic (inelastic)
Proportion of Income
If the price of a good increases, the consumer loses purchasing power. If that good takes up a large (small) portion of the consumers income his responsiveness will be significant (insignificant), or elastic (inelastic)
Time
it is expected that price elasticity increases (decreases) as more (less) time passes after the initial increase in price
Total Revenue
TR = Price * Quantity Demanded
Total Revenue and Elasticity
If demand is inelastic TR increases with a price increase
If demand is elastic TR decreases with a price increases
If demand is unit elastic TR stays the same
If demand is elastic TR decreases with a price increases
If demand is unit elastic TR stays the same
Income Elasticity
A measure of how sensitive consumption of good X is to a change in a consumer's income
Income Elasticity Formula
Ei = (%change Qd good X) / (%change income)
Luxury vs. Necessity vs. Inferior goods
If Ei > 1, the good is normal and income elastic (luxury)
If 1 > Ei > 0, the good is normal but income inelastic (a necessity)
If Ei < 0, the good is inferior
If 1 > Ei > 0, the good is normal but income inelastic (a necessity)
If Ei < 0, the good is inferior
Cross-Price Elasticity of Demand
The sensitivity of consumption of good X to a change in the price of good Y
Cross-Price Elasticity of Demand Formula
Ex,y = (%change Qd good X) / (%change Price good Y)
Compliments vs. Substitutes
A cross-price elasticity of demand less than zero identifies a complementary good
A cross-price elasticity of demand greater than zero identifies a substitute good
A cross-price elasticity of demand greater than zero identifies a substitute good
Price Elasticity of Supply
Measures the sensitivity of quantity supplied for good X when the price of good X changes
Price Elasticity of Supply Formula
Es = (%change in quantity supplied of good X) / (%change in the price of good X)
Price Elasticity of Supply over time
Because suppliers, once the price of a good has changed, usually cannot quickly change the quantity supplied, economists predict that the price elasticity of supply increase as time passes
Excise Taxes
A per-unit tax on production results in a vertical shift in the supply curve by the amount of the tax
Incidence of Tax
The proportion of the tax paid by consumers in the form of a higher price for the taxed good is greater if demand for the good is inelastic and supply is elastic
Excise tax and perfectly elastic demand
Government revenue is the least, decrease in consumption is the most, incidence of tax paid by consumers is 0%, and the incidence of tax paid by producers is 100%
Excise tax and elastic demand
Government revenue is falling, decrease in consumption is sizeable, incidence of tax paid by consumers is less than 50%, and the incidence of tax paid by producers is more than 50%
Excise tax and inelastic demand
Government revenue is rising, decrease in consumption is minimal, incidence of tax paid by consumers is more than 50%, and the incidence of tax paid by producers is less than 50%
Excise tax and perfectly inelastic demand
Government revenue is the most, decrease in consumption is 0, incidence of tax paid by consumers is 100%, and the incidence of tax paid by producers is 0%
Excise tax and perfectly elastic supply
Government revenue is the least, decrease in consumption is the most, incidence of tax paid by consumers is 100%, and the incidence of tax paid by producers is 0%
Excise tax and elastic supply
Government revenue is falling, decrease in consumption is sizeable, incidence of tax paid by consumers is more than 50%, and the incidence of tax paid by producers is less than 50%
Excise tax and inelastic supply
Government revenue is rising, decrease in consumption is minimal, incidence of tax paid by consumers is less than 50%, and the incidence of tax paid by producers is more than 50%
Excise tax and perfectly inelastic supply
Government revenue is the most, decrease in consumption is the least, incidence of tax paid by consumers is 0%, and the incidence of tax paid by producers is 100%
Dead weight loss
The lost net benefit to society caused by a movement away from the competitive market equilibrium. Policies like excise taxes create lost welfare to society
Deadweight loss and Elasticity
Deadweight loss increases as the demand or supply curves become more elastic
Subsidies
Has the opposite effect of an excise tax, as it lowers the marginal cost of production, resulting in a downward vertical shift in the supply curve for good X
Price Floors
A legal minimum price below which the product cannot be sold. If a floor is installed at some level above the equilibrium, it creates a permanent surplus
Price Ceilings
A legal maximum price above which the product cannot be sold. If a ceiling is installed at a level below the equilibrium price, it creates a permanent shortage
Utility
Happiness, benefit, satisfaction, or enjoyment gained from consumption
Total Utility
The total amount of happiness received from the consumption od a certain amount of a good
Marginal Utility
The additional utility received (or sometimes lost) from the consumption of the next unit of a good
Marginal Utility Formula
Mu = (%change Total Utility) / (%change Quantity)
Utils
A unit of measurement often used to quantify utility
Utility and Rational Decisions
Even if the monetary price of good X is zero, the rational consumer stops consuming good X at the pint where total utility is maximized
Law of Diminishing Marginal Utility
States that in a given time period, the marginal utility from consumption of one more of that item falls
Constrained Utility Maximization
For a one-good case. Constrained by prices and income, a consumer stops consuming a good when the price paid for the next unit is equal to the marginal benefit received
Utility Maximizing Rule
The consumer maximizes utility when they choose amounts of goods X and Y, with their limited income, so that the marginal utility per dollar spent is equal for both goods
Utility Maximizing Rule Formula
MUx/Px = MUy/Py or MUx/MUy = Px/Py
Deriving the Demand Curve from Utility
Utility maximizing behavior of individuals creates individual demand curves
Summing the quantity demanded by individuals at each price creates market demand curves
Summing the quantity demanded by individuals at each price creates market demand curves
Firm
An organization that employs factors of production to produce a good or service that it hopes to profitably sell
Explicit Costs
direct, purchased, out-of-pocket costs paid to resource suppliers outside the firm (Also called accounting costs)
Implicit Costs
Indirect, non purchased, or opportunity costs of resources provided by the entrepreneur (Also called economic costs)
Accounting Profits
The difference between total revenue and total explicit costs
Economic Profits
The difference between total revenue and total explicit and implicit costs
Short-run
A period of time too short to change the size of the plant, but many other, more variable resources can be adjusted to meet demand
Long-run
A period of time long enough to alter the plant size. New firms can enter the industry and existing firms can liquidate and exit
Characteristics of Firms in the Short-run
Plant size: Fixed
Fixed Cost: Some
Variable Costs: Some
Entry/Exit of Firms: None
Fixed Cost: Some
Variable Costs: Some
Entry/Exit of Firms: None
Characteristics of Firms in the Long-run
Plant size: Variable
Fixed Cost: None
Variable Costs: All
Entry/Exit of Firms: Yes
Fixed Cost: None
Variable Costs: All
Entry/Exit of Firms: Yes
Production Function
The mechanism for combining production resources, with existing technology, into finished goods and services, Inputs are turned into outputs
Fixed Inputs
Production inputs cannot be changed in the short run. Usually this is the plant size or capital
Variable Inputs
Production inputs that the firm can adjust in the short run to meet changes in demand for their output. Often this is labor and/or raw materials
Total Product (of Labor)
The total quantity, or total output, of a good produced at each quantity of labor employed
Marginal Product (of Labor)
The change in the total product resulting from a change in the labor input. MP = change in TP / change in Labor. If labor is changing one unit at a time, MP = change in TP
Average Product (of Labor)
Total product divided by the amount of labor employed. AP = TP / L
Law of Diminishing Returns
As successive units of a variable resource are added to a fixed resource, beyond some point marginal product falls
Increasing Marginal Returns
MP is increasing as Labor increases
Diminishing Marginal Returns
MP decreases as Labor increases
Negative Marginal Returns
MP becomes negative as Labor increases
If MP > AP
AP is rising
If MP < AP
AP is falling
If MP = AP
AP is at the peak; MP intersects AP at its graphical maximum
Total Fixed Costs (TFC)
Those costs that do not vary with the changes in short-run output. They must be paid even when output is zero. These include rent on a building or equipment, insurance or licenses
Total Variable Costs (TVC)
Those costs that change with the level of output. If output is zero, so are total variable cost. They include payments for materials, fuel, power, transportation services, most labor, and similar costs
Total Costs (TC)
The sum of total fixed and total variable costs at each level of output
Marginal Costs (MC)
the additional cost of producing one more unit of output MC = change in TC / change in Quantity (Output). Since TVC are the only costs that change with the level of output, marginal cost is also calculated as MC = change in TVC / change in Quantity (Output)
Average Fixed Costs (AFC)
Total fixed costs divided by output. AFC = TFC/Q. It continuously falls as output rises
Average Variable Cost (AVC)
Total variable costs divided by output. AVC = TVC/Q
Average Total Costs (ATC)
Total costs divided by output ATC = TC/Q also ATC = AFC + AVC
As MP is falling MC is
Rising
As MP is rising MC is
Falling
When MP is highest MC is
Lowest
As AP is falling AVC is
Rising
As AP is rising AVC is
Falling
When AP is highest AVC is
Lowest
Economies of Scale
Advantages of increased plant size and are seen on the downward part of the LRAC curve. LRAC falls as plant size rises
Reasons for Economies of Scale
a. Labor and managerial specialization
b. Ability to purchase and use more efficient capital goods
b. Ability to purchase and use more efficient capital goods
Constant Returns to Scale
This can occur when LRAC is constant over a variety of plant sizes
Diseconomies of Scale
The upward part of the LRAC curve where LRAC rises as plant size increases. This is usually the result of the increased difficulty of managing larger firms which results in lost efficiency and rising per unit costs
Characteristics of Perfect Competition
-Many small independent producers and consumers
-Firms produce a standardized product
-No barriers to entry/exit
-Firms are "price takers"
-Firms produce a standardized product
-No barriers to entry/exit
-Firms are "price takers"
The demand curve for goods and service produced by a perfectly competitive firms is...
Horizontal (perfectly elastic)
The market demand curve for goods and services produced by a perfectly competitive firm is...
Normal; in other words as the market price goes up quantity demanded falls and vice versa
When firms maximize economic profits this means...
They are not going to settle for anything less than the highest possible difference between total revenue and total economic cost
Economic Profit (pi)=...
Total revenue - Total Economic Cost
Profit Maximizing Point Formula
MR = MC
Demand=Price=...=...
Marginal Revenue (=ΔTR/ΔQ= PΔQ/ΔQ=P) and Average Revenue (=TR/Q=PQ=P*Q/Q=P)
Total Profit Formula
Total Profit (pi)=qe*(P-ATC)
If P > ATC then...
Profits > 0 (Positive Economic Profit)
If P < ATC then...
Profits < 0 (Negative Economic Losses)
If P = ATC then...
Profits = 0 (Zero Economic Profits or Normal Profits)
Decision to Shut Down
If TR ≥ TVC, the firm produces at a quantity where MR = MC
If TR ≤ TVC, the firm shuts down and quantity = 0
or
If P ≥ AVC, the firm produces at a quantity where MR=MC
If P ≤ AVC, the firm shuts down and quantity = 0
If TR ≤ TVC, the firm shuts down and quantity = 0
or
If P ≥ AVC, the firm produces at a quantity where MR=MC
If P ≤ AVC, the firm shuts down and quantity = 0
The MC curve above the shutdown point serves as what?
The supply curve for each perfectly competitive firm
The market supply curve is the sum of what?
The sum of all of the MC curves
Short Run
The period of time too brief for firms to change the size of their plants
Long Run
A period during which inputs can change
When firms are earning positive profits in the long run...
New firms will enter the market
When new firms enter into a market where most existing firms are earning positive profits...
Market supply will shift outward thereby lowering the market price so that all firms are earning zero profits
The break even point in the long run is what?
The long run equilibrium
When firms are making losses in the long run...
Existing firms will exit the market
When existing firms exit a market where other firms are making losses...
Market supply will shift inward thereby raising the market price so that all firms are now earning zero economic profits at the break even point
When the short run P > ATC
The firm produces at the quantity where MR = MC therefore short run economic profits are positive and in the long run firms enter the market
When the short run P = ATC
The firm produces at the quantity where MR = MC therefore short run economic profits are zero (Break-even point) and in the long run there is no net movement of firms (Firms neither enter or exit the market)
When the short run AVC < P < ATC
The firm produces at the quantity where MR = MC therefore short run economic profits are negative and in the long run firms exit the market
When the short run P < AVC
The firm produces at the quantity of zero (shut down) therefore short run economic profits are negative and in the long run firms exit the market
Break-even point
The output where ATC is minimized and economic profit is zero
Shutdown point
The output where AVC is minimized. If price falls below this point, the firm chooses to shut down or produce zero units in the short run
Perfectly competitive long-run equilibrium
Occurs when there is no more incentive for firms to enter or exit P=MR=MC=ATC and Profits=0
Normal Profit
Another way of saying that firms are earning zero economic profits or a fair rate of return on invested resources
Constant Cost Industry
Entry (or exit) of firms does not shift the cost curves of firms in the industry
Increasing Cost Industry
Entry of new firms shifts the cost curves for all firms upward
Decreasing Cost Industry
Entry of new firms shifts the cost curves for all firms downward
Monopoly
The least competitive market structure, it is characterized by a single producer, with no close substitutes, barriers to entry, and price making power
Characteristics of a Monopoly
-A single producer
-No close substitutes
-Barriers to entry
-Market power
-No close substitutes
-Barriers to entry
-Market power
Examples of barriers to entry in a monopolistic market structure
-Legal Barriers
-Economics of scale
-Control of key resources
-Economics of scale
-Control of key resources
Legal Barriers to Entry
There are patents, trademarks, and copyright laws to protect inventions and intellectual property. These legal protections do not [necessarily] provide for absolute monopoly for there are often viable substitutes available to consumers
Economies of Scale (Barrier to Entry)
As a firm grows larger in the long run, average total costs fall, providing the larger firm a cost advantage over smaller firms. If extensive economies of scale exist, an industry could evolve into one with only one enormous producer
Natural Monopoly
A case where economies of scale are so extensive that it is less costly for one firm to supply the entire range of demand
Control of Key Resources
If a firm controlled most of the available resources in the production of a good, it would be very difficult for a competitor to enter the market
Market Power
The ability to set the price above the perfectly competitive level
Monopoly Demand
The monopolist is the only provider of a good, therefore the demand for the product is the market demand for the product
Demand is elastic above the midpoint of a linear demand curve so cuts in price increase total revenue. Demand is inelastic below the midpoint; further cuts in price decrease total revenue. At the midpoint total revenue is maximized and demand is unit elastic. Recognizing this connection, the price making monopolist is...
Going to avoid the inelastic portion of the demand curve and operate at some point to the left of the midpoint
Demand is ________ sloping and P (Greater than or Less than) MR in monopoly
Downward; > (Greater than)
The firm must set output at the level where __=__. At this level of output, the monopolist sets the price from the ____________
MR=MC; Demand curve
Monopolists are no immune to...
Economic losses or shutdown
Monopoly Long-run Equilibrium
Pm>MR=MC, which is not allocatively efficient and dead weight loss exist. Pm>ATC, which is not productively efficient. Profit>0 so consumer surplus is transferred to the monopolist as profit
Price Discrimination
The selling of the same good at different prices to different consumers
Successful price discrimination is possible if these conditions exist...
1. The firm must have monopoly pricing power
2. The firm must be able to identify and separate groups of consumers
3. The firm must be able to prevent resale between consumers
2. The firm must be able to identify and separate groups of consumers
3. The firm must be able to prevent resale between consumers
Monopolistic Competition
A market structure characterized by a few small firms producing a differentiated product with easy entry in the market
Characteristics of Monopolistic Competition
-Relatively large number of firms
-Differentiated products
-Easy entry and exit
-Differentiated products
-Easy entry and exit
Monopolistically competitive firms face a _______ sloping demand curve for its ______________________
Downward; Differentiated Product
Demand for a monopolistically competitive firm is relatively _______
Elastic, because there are many similar substitutes available to consumers
The monopolistically competitive firm sets Qmc where __=__ and sets the price from the ____________
MC=MR; Demand Curve
With easy entry and exit into the monopolistically competitive industry, short-run positive profits will not last long as...
New firms enter this industry and the market share of all existing firms begins to fall (graphically this is a leftward shift in the demand curve
Entry into a monopolistically competitive industry stops when profits are
Zero and P=ATC, or when the demand curve is just tangent to ATC
In long-run monopolistic competition, the firm earns profits=0. But because of the differentiated products,...
P>MR=MC; Allocative efficiency is not achieved
Even though monopolistically competitive firms are breaking even, they are not operating at...
The minimum of ATC; productive efficiency is not achieved
Excess Capacity
The difference between the monopolistic competitors output Qmc and the output at minimum ATC (Qatc-Qmc)
This type of loss exists in monopolistically competitive markets but not to the same extent as with monopoly's
Deadweight loss
Oligopoly
A very diverse market structure characterized by a small number of interdependent large firms, producing a standardized or differentiated product in a market with a barrier to entry
There are...oligopolistic models
Many radically different
Characteristics of Oligopoly
-A few large firms
-Differentiated or standardized products
-Entry barriers
-Mutual interdependace
-Differentiated or standardized products
-Entry barriers
-Mutual interdependace
(Four-firm) Concentration Ratio
A measure of industry market power. (Sum the market share of the four largest firms and a ratio above 40% is a good indicator of oligopoly)
As the concentration ratio increases, the degree of monopoly pride-setting power...
Increases
Prisoner Dilemma
A game where the two rivals achieve a less desirable outcome because they are unable to coordinate their strategies
Dominant Strategy
A strategy that is always the best to pursue, regardless of what a rival is doing
Explicit collusive behavior between direct competitors is an _______ business practice
Illegal
Collusive Oligopoly
Models where firms agree to mutually improve their situation
Cartel
A group of firms that agree not to compete with each other on the basic of price, production, or other competitive dimensions. Cartel members operate as a monopolist to maximize their joint profits
The general idea of the cartel is...
Rather than act independently to maximize individual profits, they collectively operate as a monopolist to maximize their joint profits
Three Challenges of a Cartel Model
1. Difficulty in arriving at a mutually acceptable agreement to restrict output
2. Punishment mechanism. If the cartel can restrict output and increase the price above the current competitive level, cartel members have an incentive to cheat by producing more that their allotment. There must be some kind of deterrent to cheating
3.Entry of new firms. If the cartel members are successful in creating monopoly profits, they are faced with new firm eager to enter. If entry occurs, the cartel loses monopoly power and profit
2. Punishment mechanism. If the cartel can restrict output and increase the price above the current competitive level, cartel members have an incentive to cheat by producing more that their allotment. There must be some kind of deterrent to cheating
3.Entry of new firms. If the cartel members are successful in creating monopoly profits, they are faced with new firm eager to enter. If entry occurs, the cartel loses monopoly power and profit
Assumptions of a Competitive Labor Market
firms are price takers in both the product and factor markets; firms cannot impact the price of their product or price paid to employ more input; they will employ as much labor as necessary at the competitive wage.
Marginal Revenue Product of Labor (MRPL)
a measure of what the next unit of a resource (labor) will bring to a firm; equal to the demand of labor in a competitive factor market
MRPL= P* MPL
MRPL= P* MPL
Profit Maximizing Resource Employment
MB> MC employ more workers
MB< MC employ less workers
MB= MC do not change employment rate
MB< MC employ less workers
MB= MC do not change employment rate
Marginal Resource Cost (MRC)
measure of how much cost the firm incurs from using an additional unit of input
Labor Market: MRC= wage
Labor Market: MRC= wage
Graph of a Competitive Labor Market
MRPL= firms labor demand curve
Wage= firms labor supply curve (elastic)
Wage= firms labor supply curve (elastic)
Determinants of Resource Demand
product demand, productivity , prices of other resources (complimentary and substitution)