Economics Chapter 5: Firms' Problem

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Questions and Answers

What is the primary difference between accounting profit and economic profit?

Accounting profit includes only explicit costs.

Accounting profit accounts for opportunity costs.

Economic profit includes both explicit and implicit costs. (correct)

Economic profit includes only implicit costs.

How is the marginal product generally affected by the law of diminishing returns?

Marginal product is unaffected by changes in production scale.

Marginal product eventually decreases as additional units of input are added. (correct)

Marginal product remains constant regardless of input utilization.

Marginal product increases indefinitely as production continues.

What distinguishes economic profit from accounting profit?

Economic profit is always higher than accounting profit.

Economic profit considers opportunity costs while accounting profit does not. (correct)

Accounting profit includes implicit costs while economic profit does not.

Accounting profit is calculated on a cash basis while economic profit is not.

Which of the following best explains the law of diminishing returns?

Adding more of one input, while holding others constant, eventually yields lower per-unit returns. Signup and view all the answers

In comparing monopoly and competitive firms, how does a monopolist’s demand curve differ?

A monopolist faces a downward sloping demand curve. Signup and view all the answers

What is the significance of marginal revenue (MR) in a monopoly?

MR indicates the additional revenue generated from selling one more unit. Signup and view all the answers

How does the average revenue curve relate to market price in a monopolistic environment?

Average revenue and market price are equal at any quantity sold. Signup and view all the answers

What is the primary distinction between accounting profit and economic profit?

Economic profit accounts for opportunity costs, while accounting profit does not. Signup and view all the answers

What phenomenon explains why adding more of a variable input results in smaller increases in output after a certain point?

Law of diminishing returns Signup and view all the answers

Which typical cost curve intersects the average total cost curve at its lowest point?

Marginal cost curve Signup and view all the answers

Which of the following best describes the relationship between average product and marginal product?

When marginal product is below average product, average product will fall. Signup and view all the answers

In a perfectly competitive market, how does a firm's price relate to its marginal revenue?

Price equals marginal revenue. Signup and view all the answers

What is a key characteristic of monopoly markets compared to perfectly competitive markets?

Monopolists are the sole producers of a product without close substitutes. Signup and view all the answers

What effect does cooperation among firms in an oligopoly market tend to have?

Firms maximize collective profits similar to a monopoly. Signup and view all the answers

What kind of market structure allows firms to have significant control over their pricing decisions?

Oligopoly Signup and view all the answers

Study Notes

Firms’ Problem

Firms aim to maximize profit by understanding:
- Revenue
- Costs
- Profit
To calculate profit, consider total revenue (TR) and total cost (TC)
Profit = TR - TC
TR = Price x Quantity
Total Costs = Explicit Costs + Implicit Costs
Explicit costs: Costs that require an actual outlay of money (e.g., wages, materials)
Implicit costs: Costs incurred but not able to be seen, i.e. non-monetary outlay ( e.g., cost of the owner's time)
Accounting Profit: Total Revenue - Explicit Costs
Economic Profit: Total Revenue – Explicit Costs - Implicit Costs

Production Process

Firms need to determine how to produce goods and services as efficiently as possible
Production Function relates the quantity of inputs to the quantity of outputs
Marginal Product measures the additional outputs produced from adding one more unit of input
Law of diminishing returns states that there is a point where adding more of one input will lead to smaller increases in output

Cost Structures

Costs can be categorized as:
- Variable Costs (VC)
- Fixed Costs (FC)
Total Cost (TC) = VC + FC
Average Total Cost (ATC) = TC/Q
Average Variable Cost (AVC) = VC/Q
Average Fixed Cost (AFC) = FC/Q
Marginal Cost (MC) = Change in Total Cost / Change in Quantity
Relationship between MC and ATC:
- When MC < ATC, ATC falls
- When MC > ATC, ATC rises
- MC intersects ATC at its minimum

Profit Maximization

Firms aim to maximize profit by setting output where marginal revenue (MR) = marginal cost (MC)
If MR > MC, the firm should increase output to boost profits
If MR < MC, the firm should decrease output to maximize profits

Supply Decisions

Firms in competitive markets face a horizontal demand curve, meaning they can sell as much as they want at the market price
Marginal revenue (MR) is equal to the market price in a perfect competitive market
Firms should produce at the output level where MR = MC to maximize profits
Firms operate in the short-run and long-run
Shutdown decision: In the short-run, firms should shut down production if the market price is below AVC
Exit decision: In the long-run, firms should exit the market if the market price is below ATC

Monopoly Markets

Monopolies are single sellers in the market, giving them control over price and quantity
The firm's demand curve is the market demand curve, which is downward sloping
Marginal revenue (MR) for a monopolist is less than the price
Monopolists maximize profit by setting output where MR = MC
Monopolies create deadweight loss, which is a loss of welfare in the market
Government policies aim to reduce the monopoly power of firms

Monopolistic Markets

Monopolistic competition occurs when many firms sell differentiated products in a market
Firms in monopolistic competition have some control over price
Entry and exit of firms is relatively easy
Firms in monopolistic competition earn zero economic profit in the long-run

Oligopoly Markets

Oligopoly markets are dominated by a small number of firms
Firms in an oligopoly have to consider the reactions of other firms when making decisions
Oligopolies are often characterized by non-price competition
Oligopoly markets are prone to collusion, where firms work together to set prices and output

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Description

This quiz explores the fundamental concepts surrounding firms' profit maximization, including total revenue, costs, and profit calculations. Analyze explicit and implicit costs to differentiate between accounting and economic profit. Test your understanding of the production process and efficiency.