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ECN 212
MICROECONOMIC PRINCIPLES
FALL FINAL EXAM
QNS & ANS
Consumer Choice
Budget Constraint โ People face tradeoffs โ Can use income on one good or another โ Fixed income = budget constraint โ All combinations of two goods (consumption package) a consumer can potentially purchase with their income โ (P 1 xQ 1 )^ +^ (P 2 xQ 2 )^ =^ Income โ P = price, Q = Quantity โ โ A point to the right of the budget constraint represents a consumption package unaffordable to the consumer
Indifference Curves โ Indifference Curve: shows consumption bundles that give the consumer the same level of satisfaction โ Satisfaction is also called utility โ โ Four properties of indifference curves โ Downward sloping-negative slope โ Higher indifference curves are preferred to lower ones
Giffen Goods โ Goods that violate the law of demand โ Increase in price leads to increase in quantity demanded of an inferior good โ Relatively rare; only real example is potatoes during the Irish Potato Famine โ In class questions:
- Refer to the figure 1 below. If the consumer has an income of $600, what is the price of good X? a. $ b. $ c. $ d. $0.
- If you move from equilibrium point A to C, it is because: a. The price of chicken wings has increased b. The price of pepsi has decreased c. Income has decreased d. The price of chicken wings has decreased e. The price of pepsi has increased f. Income has increased
- In the figure below, which of the following is true? a. We can construct a demand curve for Good Y from this figure b. Bundle D is preferred to bundle A c. Bundle A is preferred to bundle B d. The price of Good Y changed e. We can construct a demand curve for good X from this figure Ans: B, B, E
โ Average product - how much output is produced per worker, holding all other factors constant โ Average product = Q / L โ Marginal Product โ How much changes with the change of one worker โ MP = ฮQ / ฮL โ โ Marginal Product decreases over time because of a too many cooks in the kitchen situation โ Law of diminishing marginal product โ The marginal product of an input declines as the quantity of the input increases โ How firms make decisions โ Hiring one more worker means explicit cost rises โ Worker will help produce more Q, generating more revenue โ Must compare the cost and benefit of hiring an additional worker Costs โ In the short run, labor is the only variable input โ Total cost = fixed cost + variable cost โ โ Average total cost is the cost per unit of output โ ATC = TC / Q โ Average Fixed Cost is the fixed cost per unit of output
โ AFC = FC / Q
โ Decreases as Q increases โ Average Variable Cost is the variable cost per unit of output โ AVC = VC / Q โ โ AVC initially decreases as Q increases, but begins to increase after a certain Q โ Usually U-shaped โ ATC = AFC + AVC โ โ U-shaped โ Economies of scale: ATC falls as Q increases โ Indicates increased efficiency โ Minimum is called efficient scale- the quantity where ATC is minimized
โ Diseconomies of scale - ATC rises with greater Q โ Usually occurs in larger companies because of organization issues In class Example Questions
- According to the figure 1 below, the fixed cost of producing 5 units is a. $ b. $ c. $ d. $ e. $
- The cost curve that intercepts the average total cost curve and the average variable cost curve in figure 2 is called a. Average fixed cost b. Fixed Cost c. Marginal Cost d. Total Cost e. Variable Cost
- In figure 3, at an output level of โYโ the average total cost is a. E b. C c. D d. B e. A
Figure 1 Ans: C, C, B Figure 2 Figure 3
โ Marginal Revenue = Change in total revenue divided by change in output = Price โ Total Revenue (TR) = P x q โ Average Revenue (AR) = TR/q = P Profit Maximization โ ฮ Profit = Marginal Revenue (MR) - Marginal Cost (MC) โ When Marginal revenue is greater than or equal to marginal cost, the firm is making a profit โ Profit will increase initially, but decrease eventually as q increases โ At any q with MR > MC, increasing q raises profit โ At any q with MR < MC, decreasing q raises profit โ Maximum profit occurs when MC = MR โ Marginal cost is firmโs supply curve How to calculate profit from a graph โ Profit = (P - ATC) * q Shutdown vs. Exit โ Shutdown: a short-run decision to not produce anything because of market conditions โ Must pay FC still โ Cost of shutting down is the revenue loss while shut down โ TR/q โ Benefit is saving variable cost while shut down โ VC/q โ If TR/q < VC/q, then P < AVC, so the firm should shut down
โ The graph above depicts a firmโs supply curve if it decides to shut down โ If P > AVC, then firm produces q where P = MC โ Exit: A long-run decision to leave the market โ Benefit: save on total cost (zero FC in the long run) โ TC/q โ Cost: Revenue loss (TR) โ TR/q โ When TR/q < TC/Q, then P < ATC, the firm should exit the market โ Graph above depicts a firmโs long run-supply curve The Short-Run Market Supply Curve โ At each price point, the market quantity supplied = the sum of all quantities supplied of individual firms Exit and Entry in the Long Run โ In the long run, new firms can freely exit and enter the market โ If existing firms earn positive economic profit: โ New firms enter, short-run market supply shifts right โ Price falls, reducing profits and slowing entry โ If existing firms incur losses: โ Some firms exit, short-run market supply shifts left โ Price rises, reducing remaining firmโs losses โ The average firm earns zero economic profit โ Zero economic profit is good because there is a positive accounting profit so firmโs can stay in business โ The long-run market supply curve is horizontal at minimum P = ATC
Chapter 15: Monopoly
Properties of a Monopoly โ Sole seller of a product โ Product has no close substitutes (unique) โ Price maker โ Barriers to entry โ Three types โ Single firm owns a key resource โ De Beers owns 90% of all diamond minds in the world โ The government gives a single firm the exclusive right to produce a good โ Patents or copyrights โ Natural Monopoly โ Has very high fixed costs โ Electricity, water, etc. โ Single firm can produce entire market quantity at a lower cost than could several firms Monopoly Demand Curve โ Market demand curve is sloped downward โ Demand curve for individual firm is horizontal โ The monopolistic demand curve is equal to the market demand curve โ Price = average revenue โ Marginal revenue < price, and can even be negative โ In competitive firms, the marginal revenue is equal to the price Monopolistic Supply Curve โ A monopoly does not have a supply curve Profit-Maximization โ The quantity where marginal revenue = marginal cost
โ Monopolies charge a price such that P > (MR = MC) โ Profit = (P-ATC)*Q Monopolies can evolve โ Pharmaceutical companies get patents for new drugs โ They are the sole producer and can charge a higher price for their products โ When the patent expires, the market becomes competitive as substitutes begin to appear โ New firms enter the market, so the price of the drug becomes lower and the quantity supplied becomes higher The Welfare Cost of Monopolies โ In a competitive market total surplus is maximized โ In a monopoly there is a greater consumer surplus โ The profit lost is called the deadweight loss Price Discrimination โ Selling the same good at different prices to different buyers โ The characteristic used in price discrimination is willingness to pay โ A firm can increase profit by charging a higher price to buyers with higher willing to pay, or a lower price to buyers with lower willingness to pay โ Slices population into different categories โ Age โ Old vs. Young โ Location
- What is the consumer surplus in a perfectly competitive market? a. [(P 1 - P 3 )Qm] + [(P 3 - P 4 )Qm]/ b. [(P 1 - P 3 )Qm] c. [(P 0 - P 1 )Qm]/ d. [(P 1 - P 3 )*(Qc-Qm)]/
- What is the deadweight loss in a monopolistic market? a. [(P 1 - P 3 )Qm] + [(P 3 - P 4 )Qm]/ b. [(P 1 - P 3 )Qm] c. [(P 0 - P 1 )Qm]/ d. [(P 1 - P 3 )*(Qc-Qm)]/
- How does the price and quantity produced change as the market goes from a monopoly to a perfectly competitive one? a. Price increases, quantity increases b. Price increases, quantity decreases c. Price decreases, quantity increases d. Price decreases, quantity decreases Ans: c, d, c
Chapter 17: Oligopoly
Properties of a Monopolistic Competition โ Many firms โ Similar but not identical products โ Product Differentiation: the product each firm produces is somewhat different from its competitors โ Taste- Coke and Pepsi โ Brand- Lululemon, Mercedes-Benz, Prada โ Advertisement- Trivago, Best Western, Holiday Inn โ Distance- Gas stations situated close to freeways โ Free entry and exit or market โ Imperfect Competition โ Profit-maximizes where Marginal Revenue = Marginal Cost (MR = MC) โ If Price > Average total cost, the firm is making a profit โ If Price < average total cost, the firm is making a lost Monopolistic-Competition vs. Monopoly vs. Perfectly Competitive Market โ Similar behavior to a monopoly in the short-run โ Closer to a perfectly competitive market in the long-run because economic profit = 0 โ If there is a profit in the short run, new firms enter market, prices and profits fall โ If there is a loss in the short-run, firms exit the market, increasing demand and prices
