ELEMENTS OF ECONOMICS (3 RD EDITION) BOOK III Compiled by J. Linn

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1 ELEMENTS OF ECONOMICS (3 RD EDITION) BOOK III Compiled by J. Linn 164 Explicit costs are those that require a monetary payment. 165 Implicit costs are those that do not require a monetary payment. 166 Economic profits are revenues less implicit and explicit costs. 167 Accounting profits are revenues less explicit costs. 168 Sunk cost is a cost that is not recoverable. 169 Sunk costs are to be ignored in future actions. 170 In short run production, not all inputs can be varied. 171 In long run production, all inputs can be varied. 172 Marginal product is the change in total product with respect to a change in one variable input. 173 In short run production, marginal product exhibits an increase, then exhibits a decrease after the point of diminishing marginal return has been passed. 174 Cost functions are functions of total output. 175 Fixed costs do not vary with the level of output. Fixed costs are sustained even when output is zero. 176 Variable costs vary with the level of output. 177 For zero output, variable costs are zero. 178 Total cost is the sum of fixed cost and variable cost. 179 For output greater than zero, average fixed cost is fixed cost divided by output. 180 For output greater than zero, average variable cost is variable cost divided by output. 181 For output greater than zero, average total cost is total cost divided by output, or the sum of average fixed cost and average variable cost. 182 Marginal cost is the change of total cost with respect to a change in output. 183 Since fixed cost does not contribute to the change in total cost, marginal cost can also be defined as the change of variable cost with respect to a change in output. 184 Average fixed cost always decreases with output. 185 If marginal cost exceeds average total cost, average total cost is increasing; if marginal cost is less than average total cost, average total cost is declining. 186 If marginal cost exceeds average variable cost, average variable cost is increasing; if marginal cost is less than average variable cost, average variable cost is decreasing. 187 If average variable cost is quadratic, marginal cost is quadratic and intersects the lowest points of the average variable cost and average total cost curves. 188 If average variable cost is linear, marginal cost is linear, starts at the same point as, and has twice the slope of average variable cost.

2 189 If average variable cost is constant, average variable cost and marginal cost are the same. 190 If marginal cost is constant or decreasing, average total cost will not have a lowest point. 191 Increasing marginal cost implies that the point of diminishing marginal return has been passed. 192 Long run planning takes place when plant size is to be selected; after plant size has been selected, short run planning is done with respect to that particular plant size. 193 The envelope of short run average total cost curves for various plant sizes constitute the planning curve or long-run average total cost curve. 194 Economics of scale are experienced in the region of a declining long run average total cost curve. 195 Diseconomies of scale are experienced in the region of an increasing long run average total cost curve. 196 The typical firm exhibits a U-shaped long run average total cost curve. 197 The minimum efficient scale is the smallest (or only) output at which the firm is operating at its lowest possible long run average total cost. 198 Markets, ranked in order of competitiveness, include pure competition, monopolistic competition, oligopoly, and monopoly. 199 Purely competitive markets have many buyers and sellers, easy entry and exit, and a homoogenous product. 200 The impact of one seller entering or leaving a purely competitive market has negligible effects on price; all sellers are price takers. 201 The demand curve faced by a seller in a purely competitive market is horizontal. 202 For a horizontal demand curve, price, average revenue, and marginal revenue are the same. 203 For a horizontal demand curve, an increase in demand is an upward movement of the curve and a decrease in demand is a downward movement of the curve. 204 A firm maximizes profit when it is operating at a quantity where price equals marginal cost, and at a price that is sufficient to recover average variable costs. 205 If a firm cannot recover its variable costs even when marginal revenue equals marginal cost, the firm should shut down. 206 The portion of a firm's marginal cost curve that is higher than average variable cost is the firm's supply curve. 207 Economic profits or losses will not exist at equilibrium in a perfectly competitive market. 208 If economic profits are positive, new firms will enter the industry, industry supply will increase, prices will fall, and profits will decline. 209 If economic profits are negative, existing firms will leave the industry, industry supply will decrease, prices will rise, and losses for the surviving firms will decline in severity. 210 At equilibrium, all surving firms will sell at the same price and be operating at the lowest points on their average total cost curves. 211 A change in equilibrium in a purely competitive market will occur as a result of a change in market demand. 212 If, at a new equilibirum at greater market demand,

3 the firms' minimum average total costs increase, the firm is an increaseing cost industry 213 Increasing cost industries are associated with a production possibility curve that exhibits increasing opportunity cost. 214 If, at a new equilibrium at greater market demand, the firms' minimum average total costs are the same as before, the industry is a constant-cost industry. 215 Constant-cost industries are associated with a production possiblity curve that exhibits constant opportunity cost. 216 Firms at equilibrium in a purely competitive market are operating at their lowest possible unit cost, hence the production in this market is efficient. 217 A monopoly, or monopolist, is a single seller in a market. 218 Barriers to entry exist for a monopoly, either because of legal restrictions on competition, economies of scale, or control over an important input. 219 The price at which a monopoly can sell its output will vary according to how much it produces, thus a monopoly is a price maker. 220 For a linear demand curve for a monopoly that sells all its output at the same price, marginal revenue starts at the same point as, and is twice as steep, as average revenue. 221 A monopoly maximizes profit when it offers a quantity where marginal revenue equals marginal cost and enough revenue is generated to cover variable costs. 222 A monopoly charges a higher price, and offers a smaller quantity than, firms in competitive equilbrium with the same cost curve. 223 A monopoly genrates a welfare loss. 224 A monopoly maximizes profit in the elastic part of its demand curve, which is equivalent to operating to the left of the maximum revenue point. 225 A countervailing argument in favor of monopoly is that persistent profits make funds available for research, development, and innovation. 226 Antitrust, or antimonopoly, law prohibits combinations in restraint of trade and particular actions if they lessen competition or tend to create a monopoly. 227 Some industries that are regulated by government are immune from the antitrust laws. 228 Any price regulation of a monopoly based on cost has the problem of asymmetric information in favor of the monopoly on what production costs actually are. 229 Any price regulation of a monopoly based on cost creates an incentive for the monopolist not to keep costs down. 230 Lawmakers and persons in charge of regulating a monopoly are not immune from influence by the monopoly. 231 For a declining marginal cost monopoly, a price set at marginal cost does not allow the monopolist to recover all of its fixed costs. 232 A price for a monopoly set at average total cost allows the monopoly to recover all costs, but generates some welfare loss. 233 Price discrimination occurs when the same product

4 or service is offered to different buyers at different prices for reasons other than difference in costs. 234 For price discrimination to exist, there must exist two or more markets with different elasticities of demand for the same good, the seller must be able to identify which market each buyer belongs to, and must be able to prevent side transactions between buyers in the different markets. 235 When demand for a product varies over time and marginal cost is increasing, it is efficient to price the product at peak demand at the higher marginal cost that exists then, and off peak demand at the lower marginal cost that exists then, and it is inefficient to charge the same price at both times. 236 In monopolistic competition, many buyers and sellers are in the market, entry and exit is easy, but each buyer offers a differentiated (unique) product. 237 Differentiation can arise from differences in the product, differences in the services associated with a product, or differences in location where the product is sold. 238 In monopolistic competition, each firm is a price maker for its product. 239 In monopolistic competition, a firm maximizes profit when it sets marginal revenue equal to marginal cost, and charges a price sufficient to cover its variable costs. 240 Profits in monopolistic competition will stimulate entry of new firms into the market, reducing the demand for firms already in the market, thereby reducing profits, until all economic profits are dissipated. 241 Losses in monopolistic competion will cause some firms to leave the market, leaving higher demand for the remaining firms, thereby making losses less severe, until all losses are dissipated. 242 At long run equilibrium, each monopolistically competitive firm's demand curve will be tangent to its average total cost curve. 243 At long run equilibrium, each monopolistically competitive firm will be at a point that is above and to the left of the minimum of the average total cost curve. 244 A monopolistically competitive firm generates welfare loss because it produces less (has more excess capacity) and charges more than a purely competitive firm with the same cost curve. 245 A countervailing argument in favor of monopolistic competition is that it creates more variety of products and services. 246 Advertising increases the cost of bringing goods to market, and manipulates the preferences of individuals with poor judgment skills, such as children. 247 A countervailing argument in favor of advertising is that it increases firm size and reduces welfare loss due to excess capacity. 248 Oligopoly has more than one, but not many, sellers. 249 The defining feature of an oligopoly is that an action by any seller has a palpable effect on the others. 250 Entry and exit barriers are high for an oligopoly.

5 251 Oligopoly can have differentiated or undifferentiated product. 252 In the leader-follower model of oligopoly, the price leader is a price maker for its share of the market, the followers are price takers, and all parties have knowledge of the actions to be taken by the others. 253 In the collusion, or cartel, model of oligopoly, sellers maximize joint profits as if they were a monopoly, then divide the profits according to an allocation rule. 254 The weakness of collusion is that each seller has the incentive to covertly undercut the price of the others, for the demand curve to each seller is more elastic than that of the whole market. 255 In the kinked-demand model of oligopoly, each seller faces a demand curve with a kink at the current price, the curve being flatter above the kink and steeper below it. 256 In the kinked-demand model of oligopoly, other sellers will take no action if one seller raises price, so the latter's demand curve above the current price will be elastic. 257 In the kinked-demand model of oligopoly, other sellers will lower prices if one seller lowers prices, so the latter's demand curve will be inelastic below the current price. 258 In the kinked-demand model of oligopoly, incentive exists for each seller neither to raise or lower prices. 259 In the kinked-demand model of oligopoly, the marginal cost curve will intersect the vertical section of a marginal revenue curve that has a vertical section of it, so quantity sold will not change even if there is a change in marginal cost. 260 In game theory models of oligopoly, each seller determines a response to each of all possible strategies by the other players, then ascertains which strategy each other player will take, and acts accordingly. 261 If the strategy selected by a game player is the same regardless of those chosen by the other players, that strategy is a dominant strategy. 262 The Nash equilibrium is that which will occur when each player knows, or believes, what the other players will do.