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3 primary factors of production
land, labor, capital
Profits and Losses
determined by calculating the difference between expenses and revenues
Total Revenue
amount a firm receives from the scale of goods and services it produces
Total Cost
amount a firm spends in order to produce the goods and services it produces

ex:john purchases $30 in materials to build a book shelf and takes half a day off from work, where he normally earns $12 an hour. After four hours, he completes the book case. Explicit costs are $30, but his implicit costs are $12(4)+$30 = $78

Explicit Costs
tangible out-of-pocket expenses

Ex: electricity bill, employee wages

total cost – implicit cost

Implicit Costs
the opportunity costs of doing business

Ex: the labor of an owner who works for the company but does not draw a salary

Accounting Profit
total revenue – explicit costs
Economic Profit
total revenues – (explicit costs + implicit costs)

always less than accounting profit

production a firm creates
Factors of production
inputs (labor, land, and capital) used in producing goods and services
Production Function
describes the relationship between inputs a firm uses and the output it creates
Marginal Product
change in output associated with one additional unit of an input

total output/change in input

ex: going from 1 worker to 2 workers increases total output from 5 to 15 meals

Diminishing Marginal Product
occurs when successive increases in inputs are associated with a slower rise in output
Variable Costs
change with the rate of output

total costs – fixed costs

ex: restaurant does not need these costs unless it has customers (burgers, electricity, employees)

Fixed Costs
unavoidable; they do not vary with output in the short run

Ex: rent, insurance, property taxes

Average Variable Cost (AVC)
AVC = TVC / Output produced
Average Fixed Cost (AFC)
TFC/Output produced
Average Total Cost (ATC)
Marginal Cost
increase in cost that occurs from producing additional output
Efficient Scale
output level that minimizes the average total cost
refers to the size of the production process
Economies of Scale
occur when costs decline as output expands in the long run
Diseconomics of Scale
occur when costs rise as output expands in the long run
Constant Returns to Scale
occur when costs remain constant as output expands in the long run
in economies, we assume that firms make decisions in order to
maximize profit
a firms economic profit is always less than its accounting profit because
economic profit considers implicit costs, which accounting does not
in the short run, average total costs at first decrease and then increase as more output is produced because
marginal cost is at first less than average total costs, then rises above it
When the average total cost curve is downwardsloping, the marginal cost curve
is below the average total cost curve
if a firm wants to cut its costs through more efficient production, we should assume that the firm is trying to
increase its profits
accounting profit is equal to
total revenue – explicit costs
Price Taker
Firms that produce goods in competitive markets

no control over the price set by the market

Characteristics of competitive firms
many sellers, similar products, free entry and exit, price taking
Assume that a firms costs are split between variable costs and fixed costs. once variable costs are covered
any extra money goes toward paying the fixed costs
Profit-maximizing rule
profit maximization occurs when a firm expands output until marginal revenue is equal to marginal cost


Sunk Costs
costs that have been incurred as a result of past decisions
if something is a perfectly competitive firm and is currently making positive economic profits of $1000
firms will enter the market
Firms will be indifferent about shutting down or producing if the price they charge is
equal to their minimum average variable cost (AVC)
hot dogs in NY can be considered to be close to a perfectly competitive market, because there are so many individuals buying and selling hot dogs
market forces set the price in the market
Firms in every market structure
will attempt to maximize profits
a firms willingness to supply its product in the long run is represented on a graph by the
part of the marginal cost curve above minimum average total cost
a firm is characterized as a price-taker
has no control over the price it pays, or receives, in the market
if a competitive firm can make enough revenue to cover its variable costs, the firm will
choose to remain open
if competitive firm is $15 and marginal cost is $15 the firm should
continue producing at current levels
all firms no matter what type of firm structure they are producing in, make their production decisions based on the point where their
marginal revenue equals marginal costs
Kathleen owns a photography business in Mobile, Alabama. The market for photography is very competitive. At Kathleen’s current production level, her marginal cost is $15 and her marginal revenue is $12. In order to maximize profi ts, Kathleen should:
decrease production
Holding all else constant, an increase in the price of hot dogs would cause the
marginal revenue curve in the market for hot dog buns to decrease
Charlie’s Churros is a perfectly competitive firm that sells desserts in Houston, Texas. Charlie’s Churros currently is taking in $40,000 in revenues, and has $15,000 in explicit costs and $25,000 in implicit costs. Holding all else constant, the price in this market will:
Stay where it is
A farmer’s market is close to being a perfectly competitive market. Which characteristic of a perfectly competitive market do most farmer’s markets violate?
many sellers
A firm’s willingness to supply its product in the short run is represented on a graph by the
part of the marginal cost (MC) curve above
minimum average variable cost (AVC)
If the market price is $15 and marginal cost is represented by the equation 2 * Q , where Q is in thousands of units, what is the profit-maximizing quantity?
When talking about economic profits in a perfectly competitive market, the difference between the
long run and the short run is that, in the short run, firms
can earn positive or negative economic profits, but in the long run, firms have zero economic
In competitive markets
firms are at the mercy of market forces
one reason why the long-run supply curve may slope upward in a competitive market is that
some resources necessary to produce the product may be available only in limited supplies
Firms always make a positive economic profit if the price they charge is
greater than their minimum average total cost
Barriers to Entry
restrict the entry of new firms in to the market
Monopoly Power
measures the ability of firms to set the price for a good
the best way for monopolies to limit competition is to
control a resource that is essential in the production process
profit-maximizing rule for a monoplist
Marginal Revenue = Marginal Cost
Most economists are against monopolies because
monopolies can never produce the quantity that a perfectly competitive market would produce
Natural Monopoly
when a single large firm has lower costs than any potential smaller competitor
Natural Barriers
ex: control of resources, problems raising capital, and economies of scale
Characteristics of Monopolies
one seller
unique product without close substitutes
high barriers to entry
price making

Monopolists charge too much and produce too little

Price Maker
some control over the price it chargers
occurs when resources are used to secure monopoly rights through the political process
Major differences between monopoly and competitive market
competitive market: many firms, produces efficient level of output, cannot earn long-run economic profits, has no market power

Monopoly- one firm, produces less than the efficient level of output, may earn long-run economic profits, has significant market power

Market Failure
occurs when the output level of a good is ineffecient
One benefit from a tarrif
protection of domestic business
Breaking up a company that has a natural monopoly would
result in higher production cost
Economies of scale exist
when long-run average total costs decrease
Tax medallions are an example of
a government-created barrier to entry
Patents and copyrights can
create strong incentives to develop new drugs
If a monopolist is producing a quantity where marginal revenue is equal to $16 and the marginal cost is equal to $17, the monopolist should
decrease production and increase the maximizing profits
When a monopolist lowers its price from $80 to $70, the quantity it is able to sell increases from 100 to 150. The change in revenue associated with the output effect is equal to
The quation of a firm’s marginal revenue curve is estimated to be P = 50 – Q (quantity), and the equations of their marginal cost curve is estimated to be P = 10 + 3Q. The profit-maximizing price for this firm is
Which of the following is a characteristic of a monopoly but not of a competitive market
Price > Marginal Cost
When a competitive market becomes controlled by a monopoly, the price ________________and the output ______________
Increases ; Decreases
Beer prices at major league baseball stadiums are usually much higher than prices at a bar or restaurant. This is mainly because
Baseball team owners have market power and can charge a higher price when they are the only sellers of the beer
Deadweight loss results in a monopoly because
some consumers who would benefit from a competitive market lose out
Papa Joe’s Car Dealership is the only dealership in Victorville, California. The owner, Papa Joe, experiences large economies of scale. Because he is the only seller of cars in the town
Papa Joe has market power
Monopolistic Competition
characterized by free entry, many different firms, and product differentiation
Product Differentiation
process that firms use to make a product more attractive to potential customers
Monopolistically competitive market consists of ____ sellers?
many sellers
exists when a small number of firms sell a differentiated product in a market with high barriers to entry

Few sellers

Monopoly consists of ___ sellers?
difference between the price the firm charges and the marginal cost of production
an agreement between netflix and flixbuster to each supply 250 subscriptions is an example of
Collusion – agreement among rival firms that specifies the price each firm charges and the quantity it produces
Excess Capacity
occurs when a firm produces at an output level that is smaller than the output level needed to minimize average total costs
a group of two or more firms that act in unison
Antitrust laws
attempt to prevent oligopolies from behaving like monopolies
industry consisting of only two firms
Mutual Interdependence
a market situation where the actions of one firm have an impact on the price and output of its competitors
Nash Equilibrium
occurs when an economic decision maker has nothing to gain by changing strategy unless it can collude
Price Effect
occurs when the price of a good or service is affected by the entrance of a rival firm in the market
Output Effect
occurs when the entrance of a rival firm in the market affects the amount produced
Game Theory
branch of mathematics that economists use to analyze the strategic behavior of decision makers
Prisoners Dilemma
occurs when decision makers face incentives that make it difficult to achieve mutually beneficial outcomes
Dominant Strategy
exists when a player will always prefer one strategy, regardless of what his opponent chooses
long-run strategy that promotes cooperation among participants by mimicking the opponents most recent decision with repayment in kind
In a repeated prisoner’s dilemma, a player that is playing tit-for-tat will
cooperate in the first round and, in any subsequent round, do what their opponent did last round
When a third firm enters a market that was previously categorized as a duopoly, the equilibrium price
will be lower and the equilibrium quantity will be higher
The shape and/or slope of the marginal revenue curve under monopolistic competition is
downward-sloping and twice as steep as the demand curve
The Nash equilibrium in an oligopolistic market is generally ________ for society than the outcome under collusion because the price is ________ marginal cost.
better ; closer to
In the long run, both monopolistic competition and competitive markets result in
zero economic profit for firms
When a market is characterized by mutual interdependence
the actions of one firm have an impact on the price and output of its competitors
Predatory Pricing
the practice of setting prices deliberately below average variable costs in order to put a rival out of business
One critical characteristic of monopolistic competition is
there are many small firms in the industry
A firm operating in an oligopolistic market has ________ market power compared to a ________
less ; monopolist
If all monopolistically competitive firms had identical cost curves
the industry would remain monopolistically competitive because of product differentiation
Example of a monopolistically competitive market
retail clothing store
We can represent the entry of new firms into a monopolistically competitive market by shifting the existing firms’
demand curves downward
markup would not exist in
a competitive market

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