Micro Economics Final Study Guide PDF

CHAPTER 7 https://quizlet.com/ca/984497391/understanding-profits-and-costs-in-economics-flash-cards/ 7.1 Profits: Total Revenues Minus Total Costs Key Concepts: ○ Opportunity Cost: Value of the best alternative for when making a choice. ○ Explicit Costs: Costs require mon...

CHAPTER 7 https://quizlet.com/ca/984497391/understanding-profits-and-costs-in-economics-flash-cards/ 7.1 Profits: Total Revenues Minus Total Costs Key Concepts: ○ Opportunity Cost: Value of the best alternative for when making a choice. ○ Explicit Costs: Costs require monetary payment (e.g., wages, rent). ○ Implicit Costs: Costs not requiring monetary payment (e.g., owner's time). ○ Economic Profit: Total revenue - (Explicit Costs + Implicit Costs). ○ Accounting Profit: Total revenue - Explicit Costs. ○ Sunk Costs: Costs already incurred and non-recoverable; irrelevant for future decisions. ○ Zero Economic Profit: Also called normal profit; indicates that a business covers both explicit and implicit costs. 7.2 Production in the Short Run Key Concepts: ○ Short Run: Period during which at least one input is fixed. ○ Production Function: Relationship between input quantities and output quantity. ○ Total Product (TP): Total output produced. Initially it increases rapidly, then more slowly. ○ Diminishing Marginal Product: Occurs when adding more of a variable input (e.g., labor) results in smaller increases in output due to fixed input constraints. ○ Marginal Product (MP): Additional output from using one more unit of input. ○ Average Product (AP): Output per unit of input. Relationships: ○ When MP > AP, AP rises. ○ When MP < AP, AP falls. 7.3 Costs in the Short Run Types of Costs: ○ Fixed Costs (TFC): Do not vary with output (e.g., rent). ○ Variable Costs (TVC): Vary with output (e.g., materials, labor). ○ Total Costs (TC): TC = TFC + TVC. Cost Per Unit: ○ Average Costs: Costs expressed on a per-unit basis.  ○ Marginal Cost (MC): Change in total cost for producing one more unit of output. See figure 1 7.4 The Shape of the Short-Run Cost Curves Key Insights: ○ Inverse Relationship: Between Marginal Product (MP) and Marginal Cost (MC). When MP rises, MC falls; when MP falls, MC rises. ○ Cost Curve Components: Total Cost (TC): Sum of TVC and TFC. Shapes of these curves reflect the underlying production function. 7.5 Cost Curves: Short Run and Long Run Key Concepts: ○ Long-Run Average Total Cost (LRATC): Depicts the lowest average total cost at each output level when all inputs are variable. ○ Relationship with Short-Run ATC (SRATC): LRATC is derived from multiple SRATC curves, representing different plant sizes. GRAPHS Figure 1. SAMPLE QUESTIONS 7 1. Opportunity Costs and Economic vs. Accounting Profit Sample Question: A business owner invests $100,000 of her own money into a business, which earns $120,000 in revenue annually. She incurs $80,000 in explicit costs and could have earned $10,000 annually from investing her money elsewhere. Calculate the accounting profit and economic profit. Solution: Accounting Profit: ○ Total Revenue - Explicit Costs ○ $120,000 - $80,000 = $40,000 Economic Profit: ○ Total Revenue - (Explicit Costs + Implicit Costs) ○ $120,000 - ($80,000 + $10,000) = $30,000 The accounting profit is $40,000, but the economic profit is $30,000 due to the opportunity cost of the owner’s forgone investment income. 2. Diminishing Marginal Product Sample Question: A bakery employs workers to produce cupcakes. The total product (output) for different numbers of workers is as follows: 1 worker: 20 cupcakes 2 workers: 50 cupcakes 3 workers: 70 cupcakes 4 workers: 80 cupcakes At what point does diminishing marginal product begin? Solution: Marginal Product (MP): Change in output from hiring an additional worker. ○ From 1 to 2 workers: MP = 50 - 20 = 30 cupcakes. ○ From 2 to 3 workers: MP = 70 - 50 = 20 cupcakes. ○ From 3 to 4 workers: MP = 80 - 70 = 10 cupcakes. Diminishing marginal product begins when MP decreases, which happens when the third worker is hired (MP drops from 30 to 20). 3. Short-Run Cost Calculations Sample Question: A factory produces widgets with the following costs: Fixed Costs (FC): $1,000 Variable Costs (VC) for 50 widgets: $2,500 Variable Costs (VC) for 51 widgets: $2,550 Calculate the Total Cost (TC), Average Total Cost (ATC), and Marginal Cost (MC) for producing 51 widgets. Solution: Total Cost (TC): ○ TC = FC + VC ○ TC for 51 widgets = $1,000 + $2,550 = $3,550 Average Total Cost (ATC): ○ ATC = TC / Quantity ○ ATC for 51 widgets = $3,550 / 51 ≈ $69.61 Marginal Cost (MC): ○ MC = Change in TC / Change in Quantity ○ MC = ($2,550 - $2,500) / (51 - 50) = $50 The factory’s ATC is approximately $69.61, and the MC for the 51st widget is $50. 4. Shape of Short-Run Cost Curves Sample Question: Why does the marginal cost curve initially decrease and then increase as production rises? Solution: Initially, the Marginal Product (MP) of labor increases due to specialization and more efficient use of fixed resources. This reduces Marginal Cost (MC). As more labor is added, Diminishing Marginal Product sets in, meaning each additional worker adds less output. This increases MC as more labor is required to produce the same additional output. 5. Relationship Between Short-Run and Long-Run Costs Sample Question: In the long run, a firm decides to expand its plant size. How will its short-run Average Total Cost (ATC) curves change? Solution: In the long run, all inputs are variable, and the firm can choose the most efficient plant size for any level of output. The short-run ATC curves for smaller and larger plants will form "U-shapes," and the Long-Run Average Total Cost (LRATC) curve will be the smooth envelope of these short-run ATC curves. Expanding the plant size may reduce costs for higher levels of output, shifting the short-run ATC curve downward for those quantities. CHAPTER 8 https://quizlet.com/ca/984498243/market-structures-and-profit-maximization-in-economics-flash- cards/ 8.1 The Four Major Market Structures Market Structures: ○ Perfect Competition: Many firms, identical products, no barriers to entry, price takers. ○ Monopolistic Competition: Many firms, differentiated products, some barriers to entry. ○ Oligopoly: Few firms, either identical or differentiated products, significant barriers to entry. ○ Pure Monopoly: One firm, unique product, significant barriers to entry, price maker. 8.2 An Individual Price Taker’s Demand Curve Perfect Competition Characteristics: ○ Firms sell at the market price, which is determined by supply and demand. ○ A perfectly competitive firm’s demand curve is a horizontal line at the market price (perfectly elastic). ○ Changes in the market price shift the firm’s demand curve. SEE FIGURE 2 8.3 Profit Maximization Key Revenue Concepts: ○ Total Revenue (TR) = Price (P) × Quantity (q). ○ In perfect competition, Price = Marginal Revenue (MR) = Average Revenue (AR). Profit-Maximizing Methods: ○ Total Revenue - Total Cost Method: Identify the output level with the highest profit. ○ Marginal Approach: Find the output level where MR = MC (the profit-maximizing point). Profit Conditions: ○ If MR > MC, increase production to boost profit. ○ If MR < MC, decrease production to reduce losses. ○ Profit is maximized where MR = MC. See figure 3 8.4 Short-Run Profits and Losses Steps to Determine Profit or Loss: ○ Identify the profit-maximizing quantity where MR = MC. ○ Calculate Total Revenue (TR = Price × Quantity). ○ Determine Total Cost (TC = Average Total Cost × Quantity). ○ Compare TR and TC: If TR > TC, the firm earns economic profit. If TR < TC, the firm incurs economic loss. If TR = TC, the firm earns normal profit (zero economic profit). Shut-Down Decision: ○ If Price < Average Variable Cost (AVC), the firm should shut down in the short run. ○ The firm’s short-run supply curve corresponds to the portion of the Marginal Cost (MC) curve above AVC. 8.5 Long-Run Equilibrium Market Dynamics:  ○ Positive economic profits attract new firms, increasing supply and reducing market price until profits reach zero. ○ Economic losses cause firms to exit, decreasing supply and raising market price until losses are eliminated. ○ Long-run equilibrium occurs when all firms earn zero economic profit, with no incentive to enter or exit the market. Supply Adjustments: ○ In the long run, all inputs are variable, and firms can adjust production or enter/exit the industry. 8.6 Long-Run Supply Market Supply Curve: ○ In a constant-cost industry, the long-run supply curve is perfectly elastic (horizontal). ○ In an increasing-cost industry, the long-run supply curve slopes upward. ○ In a decreasing-cost industry, the long-run supply curve slopes downward. Efficiency: ○ Firms operate at the lowest point on the Long-Run Average Total Cost (LRATC) curve. ○ Market price equals the minimum LRATC, ensuring productive efficiency. GRAPHS: Figure 2 Figure 3 SAMPLE QUESTIONS 8 1. Profit Maximization Method: 1. Use the Marginal Revenue (MR) = Marginal Cost (MC) rule to find the profit-maximizing quantity. 2. Calculate Total Revenue (TR): Multiply market price (P) by quantity (q). 3. Calculate Total Cost (TC): Multiply Average Total Cost (ATC) by quantity (q). 4. Determine profit or loss: ○ Profit = TR - TC. Sample Question: A firm in a perfectly competitive market faces a market price of $10 per unit. Its total cost for producing 5 units is $60, and the marginal cost of producing the 6th unit is $10. Should the firm produce the 6th unit? Solution: Check if MR = MC at the 6th unit: ○ MR = $10 (price is constant in perfect competition).  ○ MC = $10. ○ Since MR = MC, producing the 6th unit maximizes profit. Calculate TR and TC for 6 units: ○ TR = $10 × 6 = $60. ○ TC = $60 (already includes the 6th unit's cost). Profit = TR - TC = $60 - $60 = $0. ○ The firm is earning a normal profit, so producing the 6th unit is optimal. 2. Determining Economic Profit or Loss Method: 1. Find the profit-maximizing quantity where MR = MC. 2. Use the demand curve to determine the market price (P) at that quantity. 3. Compute TR = P × q. 4. Find TC by identifying ATC at that quantity and multiplying it by q. 5. Compare TR and TC: ○ If TR > TC, the firm earns economic profit. ○ If TR < TC, the firm incurs an economic loss. Sample Question: A firm produces 10 units of output, where MR = MC. The market price is $15, and ATC at 10 units is $12. Calculate the firm’s profit. Solution: TR = P × q = $15 × 10 = $150. TC = ATC × q = $12 × 10 = $120. Profit = TR - TC = $150 - $120 = $30. ○ The firm earns an economic profit of $30. 3. Short-Run Shut-Down Decision Method: 1. Determine if the price (P) is greater than or less than Average Variable Cost (AVC) at the profit-maximizing quantity. ○ If P < AVC, shut down. ○ If P ≥ AVC, continue producing in the short run. Sample Question: A firm faces a market price of $8. At its profit-maximizing output, AVC is $9, and ATC is $12. Should the firm shut down in the short run? Solution: Compare price with AVC: ○ Price ($8) < AVC ($9). ○ Since price is below AVC, the firm should shut down in the short run. 4. Long-Run Equilibrium Method: 1. Determine if firms are making economic profit or loss in the short run: ○ Positive profit leads to entry, increasing supply and lowering price. ○ Losses lead to exit, decreasing supply and raising price. 2. Long-run equilibrium occurs when Price = ATC, and firms earn zero economic profit. Sample Question: In a perfectly competitive market, the current price is $20, and firms are making an economic profit. Explain what will happen in the long run. Solution: Economic profits attract new firms, increasing market supply. Increased supply lowers the market price. Entry continues until Price = ATC and firms earn zero economic profit. In the long run, firms operate at the minimum point of their ATC curve. 5. Long-Run Supply Curve Method: 1. Assess the industry’s cost structure: ○ Constant-cost industry: Long-run supply curve is horizontal. ○ Increasing-cost industry: Long-run supply curve slopes upward. ○ Decreasing-cost industry: Long-run supply curve slopes downward. 2. Determine the equilibrium market price and quantity based on the intersection of market demand and long-run supply. Sample Question: In a constant-cost industry, the market price is $50. Firms are operating at their minimum ATC. If demand increases, what happens to the long-run market price? Solution: In a constant-cost industry, long-run supply is perfectly elastic.  An increase in demand raises the quantity produced but does not affect the price. The long-run market price remains $50. CHAPTER 9 https://quizlet.com/ca/984499007/monopoly-power-and-profit-maximization-flash-cards/ 9.1 Monopoly: The Price Maker Sources of Monopoly Power: ○ Legal barriers, such as franchising, licensing, and patents. ○ Economies of scale, leading to natural monopolies (e.g., utilities). ○ Control of essential inputs, where a single firm controls access to critical resources. Examples: ○ LCBO, which has a monopoly over distilled spirits in Ontario. ○ Pure monopolies are rare, but near-monopolies (like regional utilities) are more common. 9.2 Demand and Marginal Revenue in Monopoly Monopolist's Demand Curve: ○ The monopolist faces the market demand curve, which is downward sloping.  ○ To sell more output, the monopolist must lower the price for all units sold, which causes marginal revenue (MR) to be less than price. Elasticity and Revenue: ○ When demand is elastic, lowering the price increases total revenue, and MR is positive. ○ When demand is inelastic, lowering the price decreases total revenue, and MR is negative. ○ A monopolist will never operate in the inelastic portion of the demand curve. See figure 4 9.3 The Monopolist’s Equilibrium Profit-Maximizing Rule: ○ A monopolist maximizes profit where marginal revenue (MR) equals marginal cost (MC). ○ Producing more beyond this point increases costs faster than revenue, reducing profit. Steps to Calculate Profit or Loss: ○ Find the quantity where MR equals MC. ○ Use the demand curve to determine the price at this quantity. ○ Calculate total revenue (price multiplied by quantity). ○ Calculate total cost (average total cost multiplied by quantity). ○ Profit or loss is the difference between total revenue and total cost. Long-Run Profits: ○ Monopoly profits can persist in the long run due to barriers to entry, unlike in perfect competition. See figure 5 Graphs Figure 4 Figure 5 SAMPLE QUESTIONS 9 1. Identifying the Profit-Maximizing Output Question: A monopolist faces the following demand schedule and costs. Determine the profit-maximizing price and quantity. Quantity Price Total Cost 1 $10 $6 2 $9 $11 3 $8 $18 4 $7 $27 5 $6 $38 Solution: 1. Calculate total revenue (TR = price × quantity). 2. Calculate marginal revenue (MR = change in TR). 3. Calculate marginal cost (MC = change in total cost). 4. Find where MR equals MC. Step-by-step:  Total Revenue (TR): ○ 1 unit: $10 × 1 = $10 ○ 2 units: $9 × 2 = $18 ○ 3 units: $8 × 3 = $24 ○ 4 units: $7 × 4 = $28 ○ 5 units: $6 × 5 = $30 Marginal Revenue (MR): ○ 1 to 2 units: $18 - $10 = $8 ○ 2 to 3 units: $24 - $18 = $6 ○ 3 to 4 units: $28 - $24 = $4 ○ 4 to 5 units: $30 - $28 = $2 Marginal Cost (MC): ○ 1 to 2 units: $11 - $6 = $5 ○ 2 to 3 units: $18 - $11 = $7 ○ 3 to 4 units: $27 - $18 = $9 ○ 4 to 5 units: $38 - $27 = $11 Profit-Maximizing Output: ○ MR equals MC at 3 units (MR = $6, MC = $7). Price: ○ At 3 units, the price is $8. Total Revenue and Total Cost: ○ TR = $8 × 3 = $24 ○ TC = $18 ○ Profit = $24 - $18 = $6. The monopolist produces 3 units, charges $8, and earns $6 in profit. 2. Monopoly vs. Perfect Competition Question: Why is the equilibrium price higher and output lower in monopoly compared to perfect competition? Solution: Monopoly: Faces a downward-sloping demand curve and restricts output to maximize profit, leading to higher prices and lower quantities. Perfect Competition: Firms produce at the point where price equals marginal cost, leading to lower prices and higher quantities. CHAPTER 12 https://quizlet.com/ca/984499651/understanding-externalities-in-economics-flash-cards/ 12.1 Externalities Definition: ○ An externality is a cost or benefit from consumption or production that spills over to parties not involved in the activity. ○ The free market tends to misallocate resources when externalities are present, requiring regulation, taxes, or subsidies. Negative Externalities: ○ Occur when costs spill over onto others, such as air pollution from steel mills. ○ Result in overproduction and inefficiency because the private cost of production is lower than the true social cost. ○ Efficient output occurs when the industry is forced to internalize these external costs, producing at a socially optimal level (Q_social). Positive Externalities: ○ Occur when benefits spill over to others, such as education improving societal outcomes. ○ Result in underproduction because private benefits are less than social benefits. ○ Governments address this by providing subsidies or enforcing regulations to encourage higher production. Government Interventions: ○ For negative externalities: Taxes: Increase private costs to align with social costs. Regulation: Restrict activities causing externalities. ○ For positive externalities: Subsidies: Reduce costs for activities that generate social benefits. Regulation: Mandate beneficial activities, such as vaccinations. See figure 7 12.2 Negative Externalities and Pollution Social Costs: ○ Social cost = Private cost + External cost. ○ Negative externalities exist when social costs exceed private costs.  ○ Efficient production occurs when marginal social cost (MSC) equals marginal social benefit (MSB). Internalizing Externalities: ○ Forcing producers to compensate for external costs leads to reduced production and higher prices, aligning output with socially optimal levels. Challenges in Measuring Externalities: ○ Quantifying the divergence between private and social costs is complex. ○ Many costs, such as health impacts, are non-monetary and difficult to measure. See figure 6 Graphs Figure 6 Figure 7 PRACTICE PROBLEMS 12 Example 1: Identifying the Impact of Negative Externalities Question: A factory produces 100 units of output at a marginal private cost of $50 per unit. The marginal external cost caused by pollution is $20 per unit. What is the marginal social cost, and how does it affect efficiency? Solution: Marginal Social Cost (MSC) = Marginal Private Cost (MPC) + Marginal External Cost. MSC = $50 + $20 = $70 per unit. If the factory is not forced to account for the external cost, it overproduces because the true cost to society ($70) is higher than the private cost ($50). The efficient level of production would occur where MSC equals the market price. Example 2: Correcting for Positive Externalities Question: Education generates a positive externality valued at $500 per student, but the market provides only 1,000 students instead of the socially optimal level of 1,200. How can the government address this inefficiency? Solution: To increase production to 1,200 students, the government can: ○ Provide a subsidy of $500 per student to encourage additional education. ○ Enforce regulations, such as mandatory schooling, to ensure sufficient supply. These actions align private benefits with social benefits, leading to a socially optimal outcome. Example 3: Taxation to Reduce Negative Externalities Question: A coal plant produces 50 units of electricity, causing $1,000 in total external costs due to pollution. How much should the government tax the plant per unit to internalize the externality? Solution: Tax per unit = Total External Cost / Quantity. Tax = $1,000 / 50 = $20 per unit. By imposing a $20 tax per unit, the plant's private cost aligns with the social cost, reducing output to the efficient level.