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Questions and Answers
What does AvTC depend on?
starting amount of TOTAL FIXED COST
What does the U-shape of the long-run average cost curve generally indicate?
The profit maximization formula is Π= (pq) – (cq) where Πrepresents ________.
profit
What does the 'elasticity of demand' measure?
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What is a normal good?
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What is the main objective of a firm according to the Neo-Classical Firm Theory?
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In the short run, the quantity of fixed factors of production can vary.
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The relationship between income and demand for goods is captured by the ______ curve.
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Study Notes
Conceptual Building Blocks: Market, Demand, Supply
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Demand and Supply Functions:
- Demand function: represents the quantity of a good that consumers are willing to buy at a given price level (ceteris paribus).
- Supply function: represents the quantity of a good that firms are willing to sell at a given price level (ceteris paribus).
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Aggregate Demand and Supply Curves:
- Represent the relationship between the price level and the quantity of a good demanded or supplied.
- Shifts in the curves occur when there are changes in factors other than the price level.
- Elasticity of Demand: measures how responsive the quantity demanded is to changes in the price level or other factors.
- Market Equilibrium: occurs when the quantity demanded equals the quantity supplied at a given price level.
The Aggregate Demand and Supply Curve
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Excess Demand or Supply: occurs when the quantity demanded is not equal to the quantity supplied at a given price level.
- Excess demand: quantity demanded exceeds quantity supplied.
- Excess supply: quantity supplied exceeds quantity demanded.
Shifts in the Demand and Supply Curves
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Changes in Factors:
- Changes in income, prices of related goods, tastes, and expectations can shift the demand curve.
- Changes in production costs, technology, and expectations can shift the supply curve.
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Normal and Inferior Goods:
- Normal goods: demand increases with increasing income.
- Inferior goods: demand decreases with increasing income.
The Neo-Classical Firm Theory
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Key Assumptions:
- Firms produce using technology to transform inputs into outputs.
- Firm as a "black box" with no influence by context or internal dynamics.
- The owner of the firm is also its manager, with no separation of roles.
- All benefits and burdens of business activity are fully expressed by revenues and costs.
- The sole objective of the firm is to maximize profit.
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Profit Maximization:
- Profit (Ï€) = Total Revenue (TR) - Total Cost (TC).
- The firm aims to maximize profit by minimizing total costs.
The Production Function
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Step 1: Identify the Relationship between Output and Inputs:
- Output (q) = f(L, K), where L is labor and K is capital.
- Simplifying: q = f(L, K).
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Step 2: Identify the Optimal Quantity to Produce:
- Minimize total costs by using the optimal combination of inputs.
The Short Run and Long Run
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Short Run:
- A time interval during which the quantity of certain inputs (fixed factors) cannot vary.
- Labor is the most easily variable factor in the short run.
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Long Run:
- A time interval during which both inputs can vary (but not technology).
- The firm plans market entry, expansion, or contraction of its operations.
The Short Run
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Production Function:
- Total product (TP): quantity produced during a certain time interval using all inputs.
- Average product (AP): TP/L, the quantity of product produced on average by each unit of labor employed.
- Marginal product (MP): ΔTP/ΔL, the change in total product corresponding to the use of an additional unit of the variable input.
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Law of Diminishing Returns:
- Given a certain fixed amount of capital, if the firm uses increasing amounts of labor, there will be a point from which the average product and the marginal product will begin to decline.
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Total Cost:
- Total fixed cost (TFC): the cost incurred to produce a given quantity of product in a given unit of time, constant in the short run.
- Total variable cost (TVC): the cost incurred to produce a given quantity of product in a given unit of time, increasing in the short run.
The Long Run
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Optimal Amount of L and K:
- The optimal amount of labor and capital is determined by the ratio of their marginal productivities.
- The firm aims to minimize the long-run average cost.
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Long Run Average Cost Curve:
- Indicates the lowest unit costs at which each level of output can be produced.
- The U-shape of the curve is related to the returns to scale.
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Returns to Scale:
- Increase in the initial part of the curve, leading to a decrease in unit costs as the volume of production increases.
- Decrease in the final part, due to an increase in average costs.
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Description
A quiz on the fundamental concepts of microeconomics, covering demand and supply functions, aggregate demand and supply curves, and their economic meaning.
