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MICROECONOMICS EXAM REVIEW
CHAPTERS 8 THROUGH 12,
16, 17 AND 19
Key Terms and Concepts to Know
CHAPTER 8 - PERFECT COMPETITION
I. An Introduction to Perfect Competition A. Perfectly Competitive Market Structure:
- Has many buyers and sellers.
- Sells a commodity or standardized product.
- Has buyers and sellers who are fully informed.
- Has firms and resources that are freely mobile.
- Perfectly competitive firm is a price taker; one firm has no control over price. B. Demand Under Perfect Competition: Horizontal line at the market price II. Short-Run Profit Maximization A. Total Revenue Minus Total Cost: The firm maximizes economic profit by finding the quantity at which total revenue exceeds total cost by the greatest amount. B. Marginal Revenue Equals Marginal Cost in Equilibrium
- Marginal Revenue: The change in total revenue from selling another unit of output:
- MR = ΔTR/Δq
- In perfect competition, marginal revenue equals market price.
- Market price = Marginal revenue = Average revenue
- The firm increases output as long as marginal revenue exceeds marginal cost.
- Golden rule of profit maximization. The firm maximizes profit by producing where marginal cost equals marginal revenue. C. Economic Profit in Short-Run: Because the marginal revenue curve is horizontal at the market price, it is also the firm’s demand curve. The firm can sell any quantity at this price. III. Minimizing Short-Run Losses The short run is defined as a period too short to allow existing firms to leave the industry. The following is a summary of short-run behavior: A. Fixed Costs and Minimizing Losses : If a firm shuts down, it must still pay fixed costs. A firm produces if total revenue exceeds the variable cost of production.
B. Marginal Cost Equals Marginal Revenue : The firm produces rather than shuts down if there is some rate of output where the price at least covers average variable cost. This minimizes the short-run loss. C. Shutting Down in the Short Run : Shut down if average variable cost exceeds price at all rates of output since this minimizes loss. D. Fixed costs are a sunk cost in the short run IV. The Firm and Industry Short-Run Supply Curves A. Short-Run Firm Supply Curve: That portion of a firm’s marginal cost curve that intersects and rises above the low point on its average variable cost curve. B. Short-Run Industry Supply Curve: Sums horizontally each firm’s short-run supply curve. C. Firm Supply and Market Equilibrium: Each perfectly competitive firm selects the short-run output that maximizes profit or minimizes loss. V. Perfect Competition in the Long Run
- Zero Economic Profit in the Long Run: or exit of firms drives economic profit to zero so firms earn only a normal profit. A. The Long-Run Adjustment to a Change in Demand
- Effects of an Increase in Demand: Increase in demand results in an increase in market price. This draws new firms to enter the market which causes supply to increase pushing prices down.
- Effects of a Decrease in Demand: Decrease in demand results in a decrease in market prices.
- Market output falls. Short-run losses will eventually drive firms out of industry causing a reduction in supply. VI. The Long-Run Industry Supply Curve : Shows the relationship between price and quantity supplied once firms fully adjust to any short-term economic profit or loss resulting from a change in demand. A. Constant-Cost Industries: Horizontal supply curve; resource prices and other production costs remain constant as output expands. B. Increasing-Cost Industries: Upward-sloping supply curve; resource prices and other production costs increase as output expands. VII. Perfect Competition and Efficiency A. Productive Efficiency: Making Stuff Right: Produce output at the minimum of the long-run average cost curve. Making stuff right but maybe making the wrong stuff B. Allocative Efficiency: Making the Right Stuff Produce the output that consumers value most. Produce where marginal benefit equals marginal cost. Not only making stuff right but making the right stuff. C. What’s So Perfect About Perfect Competition?
- Gains from voluntary exchange through competitive markets:
- Consumer Surplus: Most consumers would be willing and able to pay for each good exceeds what they actually do pay.
- Producer Surplus: Total revenue minus variable costs.
- Graphical Solution: The profit-maximizing rate of output is found where the upward-sloping marginal cost curve intersects the marginal revenue curve. The price the monopolist can charge is limited by consumer demand. B. Short-Run Losses and the Shutdown Decision: Continue producing if the price is greater than average variable cost. Shutdown if the price does not cover average variable cost. C. Long-Run Profit Maximization: Barriers to entry can allow economic profit to persist in the long run. IV. Monopoly and the Allocation of Resources A. Price and Output Under Perfect Competition: Marginal benefit that consumers derive from a good equals the marginal cost of producing that good. The market is allocatively efficient and maximizes social welfare. B. Price and Output Under Monopoly: While producing to maximize profit where marginal cost equals marginal revenue, the monopolist charges a higher price and supplies less output than a perfect competitor. Consumer surplus still exists, only in smaller amounts. Social welfare is not maximized. C. Allocative and Distributive Effects: Consumer surplus is smaller under monopoly. Some of this loss in consumer surplus is redistributed to the monopolist, but some is a deadweight loss, or welfare loss, that is gained by no one. V. Problems Estimating the Deadweight Loss of Monopoly A. Why the Deadweight Loss of Monopoly Might Be Lower : Monopolists might be able to produce output at a lower cost than competitive firms. However, fear of public scrutiny and political pressure may not let monopoly price rise as high as it could. B. Why the Deadweight Loss of Monopoly Might Be Higher : Resources used by the monopolist to secure and maintain a monopoly position may create more of a welfare loss than simple models suggest. Insulated from competition, the monopolist may become inefficient. VI. Price Discrimination Charging different prices for the same output to different groups of consumers. A. Conditions for Price Discrimination: The monopolist must:
- Be a price maker.
- Identify at least two classes of consumers with different price elasticities of demand.
- Be able, at little cost, to charge each group a different price for essentially the same product.
- Have a way to prevent those consumers charged the lower price from reselling to those who pay the higher price. B. A Model of Price Discrimination: Profit is maximized by charging a lower price to the group with the more elastic demand. C. Perfect Price Discrimination: The Monopolist’s Dream
- Charge a different price for each unit of a good.
- Converts every dollar of consumer surplus into economic profit.
CHAPTER 10 - MONOPOLISTIC COMPETITION AND OLIGOPOLY
I. Monopolistic Competition : Characteristics of Monopolistic Competition : A market structure characterized by a large number of firms selling products that are close substitutes, yet different enough that each firm’s demand curve slopes downward. Each supplier is a price maker. Barriers to entry are low and firms can enter or leave the industry in the long run. Sellers also behave competitively. A. Product Differentiation
- Physical Differences: Physical appearance and qualities.
- Location: The number and variety of locations where product is available.
- Services: Accompanying services provided.
- Product Image: Image producer tries to convey the product’s quality to the buyer. B. Short-Run Profit Maximization or Loss Minimization : Elasticity of demand for a monopolistic competitor depends on the number of rival firms and the firm’s ability to differentiate its product.
- Marginal Revenue Equals Marginal Cost: Monopolistic competition maximizes profit in the short run just as a monopolist does. Profit maximizing quantity is where marginal revenue equals marginal cost; the profit-maximizing price for that quantity is found on the demand curve.
- Maximizing Profit or Minimizing Loss in the Short Run: As long as the price is at or above the average variable cost, the firm should produce in the short run. C. Zero Economic Profit in the Long Run : Because market entry is easy, monopolistically competitive firms earn zero economic profit in the long run. Monopolistically competitive firms spend large amounts on advertising, which contributes to an increase in average costs. § Monopolistic Competition is like monopoly in that they both face downward sloping demand curves. § Monopolist Competition is like perfect competition in the sense they are both easy to enter and exit that eliminate economic profit in the long run. D. Monopolistic Competition and Perfect Competition Compared : If the two types of firms have the same cost curves, the monopolistic competitor produces less and charges more than the perfect competitor, exhibiting excess capacity in the long run. II. An Introduction to Oligopoly : Varieties of Oligopoly : An industry characterized by just a few firms whose behavior is interdependent.In some industries the product is identical or undifferentiated; in others, it is differentiated across producers. § Undifferentiated Oligopolies: Sells a commodity. § Differentiated Oligopolies: Sells products that differ across producers. A. Economies of Scale : If a firm’s minimum efficient scale is relatively large compared to industry output, only a few firms are needed to satisfy industry demand. B. High Cost of Entry : High start-up costs and established brand names deter new entrants. C. Crowding Out the Competition: Multiple products from the same brand crowd out new entrants.
- Higher Profits under Oligopoly: Profit in the long run should be higher under oligopolies than under perfect competition.
CHAPTER 11 - RESOURCE MARKETS
I. The Once-Over A. Resource Demand: A firm demands additional units of a resource as long as the marginal revenue generated by that additional unit exceeds its marginal cost. B. Resource Supply: Resource owners supply their resources to the highest-paying alternative, other things constant. II. The Demand and Supply of Resources: Differences between the profit-maximizing goals of firms and utility-maximizing goals of households are sorted out through voluntary exchange in markets. A. The Market Demand for Resources : The demand for a resource is derived from the demand for the product the resource produces. B. The Market Supply for Resources : Resource suppliers are more willing and more able to increase quantity supplied as the resource price increases. III. Temporary and Permanent Resource Price Differences : As long as nonmonetary benefits are identical and resources are freely mobile, resources adjust across uses until they earn the same in different uses. A. Temporary Differences in Resource Prices: Some price differences are temporary because they spark shifts of resource supply away from lower-paid uses and toward higher-paid uses. B. Permanent Differences in Resource Prices: A lack of resource mobility, differences in inherent quality of the resource, differences in time and money involved in developing necessary skills, or nonmonetary differences explain permanent price differences for otherwise similar resources. IV. Opportunity Cost and Economic Rent : Opportunity cost is what the resource could earn in its best alternative use. Economic rent is that portion of a resource’s total earnings that exceeds the amount necessary to keep the resource in its present use. A. Resource Market A: All Earnings Are Economic Rent: In a perfectly inelastic market, resources have no alternative use so all earnings are economic rent. Fixed supply determines the equilibrium quantity, but demand determines the equilibrium price. B. Resource Market B: All Earnings Are Opportunity Costs: In a perfectly elastic market, a resource can earn as much in its best alternative use as in its present use. The horizontal supply curve determines the equilibrium wage, but demand determines the equilibrium quantity.
C. Resource Market C: Earnings Include Both Economic Rent and Opportunity Costs: When the resource supply curve slopes upward, earnings include both economic rent and opportunity costs. V. A Closer Look at Resource Demand A. The Firm's Demand for a Resource: As a firm hires more of a resource, the marginal product of that resource declines, reflecting the law of diminishing returns. B. Marginal Revenue Product: The change in total revenue when an additional unit of a resource is employed, other things constant.
- Selling Output in Competitive Markets: Marginal revenue product equals marginal product of the resource multiplied by the product price. Marginal revenue product falls because of diminishing returns.
- Selling Output with Some Market Power: Marginal revenue product curve slopes downward both because of diminishing marginal returns and because additional output can be sold only if the price falls. C. Marginal Resource Cost: The change in total cost when an additional unit of a resource is hired, other things constant. Firms hire more resources as long as doing so adds more to revenue than to cost. Firms stop hiring when MRP=MRC. D. Resource Employment to Maximize Profit or Minimize Loss: The firm hires more labor as long as doing so add more to the revenue than to the cost – that is as long labor’s marginal revenue product exceeds its marginal resource cost. E. Optimal Input and Optimal Output Decisions Are Equivalent: In equilibrium, the marginal rate of output equals the marginal cost. F. Changes in Resource Demand
- Change in Other Resources Employed: Changes in the price of resource substitutes affect demand for resources. If two resources are substitutes, an increase in the price of one increases demand for the other. If two resources are complements, a decrease in the price of one leads to an increase in demand for the other.
- Changes in Technology: Technological improvements can enhance the productivity of some resources but make other resources obsolete.
- Changes in the Demand for the Final Product: Any change in the demand for output affects resource demand. G. Optimal Use of More than One Resource: Employers hire each resource up to the point at which the last unit hired adds as much to revenue as to cost.
CHAPTER 12 - LABOR MARKETS AND LABOR UNIONS
I. Labor Supply A. Labor Supply and Utility Maximization: Two sources of utility are the consumption of goods and services and the enjoyment of leisure.
- Three Uses of Time: Market work is time sold in the labor market in return for a wage; nonmarket work is time spent producing your own goods and services, and includes time spent acquiring an education; leisure is time spent on nonwork activities.
A. Types of Unions: A craft union consists of workers with a particular skill, such as plumbers or carpenters; an industrial union consists of skilled, semiskilled and unskilled workers in an industry, such as all auto workers or all steel workers. B. Collective Bargaining, Mediation and Arbitration:
- Collective Bargaining: The process by which representatives of union and management negotiate a mutually agreeable labor contract
- Mediation and Arbitration: A mediator is an impartial observer who listens to differences between union and management separately, then suggests a resolution. Mediators have no power to impose settlement; with binding arbitration, a neutral third party evaluates the position of both management and union and issues a ruling that both parties must accept. C. The Strike: A union’s attempt to withhold labor from a firm to stop production. IV. Union Wages and Employment A. Inclusive, or Industrial, Unions – Negotiating A Higher Industry Wage: Union attempts to negotiate industry wide-wages for each class of labor; the wage rate is higher and employment is lower than without the union. B. Exclusive, or Craft, Unions – Reducing Labor Supply: Usually limit the supply of union labor, resulting in an increase in wages and a reduction in employment. C. Increasing Demand for Union Labor: This approach is attractive because it increases both the wage and employment.
- Increasing Demand for Union-Made Goods: Demand for labor is derived; increasing demand for union-made goods increases demand for union labor.
- Restrict Supply of Nonunion-Made Goods: Usually through trade restrictions.
- Increase Productivity of Union Labor: Unions assist in labor-management relations.
- Featherbedding: Union efforts to dictate wage and quantity of labor that must be hired at that wage rate. D. Recent Trends in Union Membership:
- Rates have declined steadily, as has strike activity.
- Right-to-Work: Says that workers in unionized companies cannot be forced to join a union or pay union dues. There has been an increase in the number of states that have adopted this law.
CHAPTER 16 - PUBLIC GOODS AND PUBLIC CHOICE
I. Public Goods A. Private Goods, Public Goods, and In Between: Public goods are nonrival in consumption and nonexclusive; private goods are rival and exclusive; a natural monopoly is nonrival but exclusive; and open-access goods are rival but nonexclusive. B. Optimal Provision of Public Goods: The market demand curve equals the vertical sum of each consumer’s demand for that good. The efficient level is where the market demand curve intersects marginal cost. C. Paying For Public Goods: The free-rider problem occurs because people try to benefit from public goods without paying for them.
II. Public Choice in Representative Democracy A. Median-Voter Model: Predicts that under certain conditions, the preference of the median, or middle, voter will dominate other choices. B. Special Interest and Rational Ignorance:
- Special Interest: One theory about government behavior holds that elected officials try to maximize their political support. This may imply catering to special interests rather than serving the interest of the public.
- Rational Ignorance: A stance adopted by voters who find that the cost of understanding and voting on a particular issue usually exceeds the expected benefit of doing so. Most individuals believe their time is better invested in making private choices rather than public choices because the payoff is more immediate, more direct, and more substantial. C. Distribution of Costs and Benefits: Possible combinations of benefits and costs yield four possible categories of distributions: (1) widespread benefits and widespread costs, (2) concentrated benefits and widespread costs, (3) widespread benefits and concentrated costs, and (4) concentrated benefits and concentrated costs.
- Traditional public-goods legislation: Widespread benefits and widespread costs (national defense).
- Special-interest legislation: Concentrated benefits but widespread costs (small group benefits with program costs spread across nearly all taxpayers and consumers).
- Populist legislation: Widespread benefits but concentrated costs (tort-reform legislation).
- Competing-interest legislation: Concentrated benefits and concentrated costs (legislation affecting how labor unions deal with employers). III. Exploiting Government Versus Avoiding Government A. Rent Seeking:
- Earnings that exceed opportunity cost. An activity that interest groups undertake to secure special favors from government. B. The Underground Economy: All market activity that goes unreported to the government either to avoid taxes or because the activity is illegal. IV. Bureaucracy and Representative Democracy: Bureaus are government departments and agencies charged with implementing legislation; they are financed by appropriations from legislative bodies. A. Ownership and Funding of Bureaus: Taxpayers are, in a sense, owners of government bureaus. Unlike a firm, ownership of a bureau is not transferable. When bureaus earn a “profit,” taxes may decline; when the bureaus sustain a “loss,” taxes are raised. B. Ownership and Organizational Behavior: Because public goods and services are not sold in markets, government bureaus receive less consumer feedback and have less incentive to act on any feedback they do receive. Because ownership of bureaus is not transferable, there is less incentive to eliminate waste and inefficiency. C. Bureaucratic Objectives: One theory holds that bureaus try to maximize their budgets because of the size, prestige, amenities, staff, and pay that go with a bigger budget.
Federal efforts to address the common-pool problem of air, water, and soil pollution are coordinated by the Environmental Protection Agency (EPA). A. Air Pollution : Smog is the most visible form of air pollution. B. Water Pollution : Two major sources: sewage and chemicals. About two-thirds of chemical pollutants in water come from nonpoint pollution, agricultural pesticide and fertilizer runoff. C. Hazardous Waste and the Superfund : Chemicals can pose a risk at every stage of their production, use, and disposal. Superfund law requires any company that generates, stores, or transports hazardous waste to pay to clean up any wastes that are improperly disposed. D. Solid Waste: “Paper or Plastic?” About 70 percent of the nation’s garbage goes to landfills, 15 percent is recycled, and 15 percent is incinerated. IV. Positive Externalities: Occur when consumption or production benefits other consumers or other firms.
CHAPTER 19 - INTERNATIONAL TRADE
I. The Gains from Trade : Each country specializes in making goods with the lowest opportunity cost. A. A Profile of Exports and Imports: U.S. exports of goods and services amounted to 14% of GDP in 2011. The largest category of exports is services which accounted for 29% of all U.S. exports. Capital goods and industrial supplies and materials together account for 47%. U.S. imports of goods and services were 18% of GDP in 2011. The three largest imports are industrial supplies, consumer goods, and capital goods. B. Production Possibilities Without Trade:
- Autarky: A situation of national self-sufficiency in which there is no economic interaction with foreign producers or consumers. C. Consumption Possibilities Based on Comparative Advantage : According to the law of comparative advantage, each country should specialize in producing the good with the lower opportunity cost. D. Reasons for International Specialization
- Differences in Resource Endowments: Countries export products they can produce more cheaply in return for products that are unavailable domestically or are cheaper elsewhere.
- Economies of Scale: Countries can gain from trade if the long-run average cost of production falls as the rate of production increases.
- Differences in Tastes: Different tastes across countries prompt trade.
- More Variety: Increase the variety of goods and services available. II. Trade Restrictions and Welfare Loss A. Consumer Surplus and Producer Surplus from Market Exchange : Market exchange usually generates a surplus, or a bonus, for both consumers and producers.
B. Tariffs : Taxes on imports—either specific, such as $5 per barrel of oil—or ad valorem—a percentage of the import price at the port of entry. C. Import Quotas : Legal limit on the amount of a commodity that can be imported. By limiting imports, the quota raises the domestic price above the world price and reduces quantity below the free-trade level. D. Quotas in Practice : By rewarding domestic and foreign producers with higher prices, the quota system creates two groups intent on securing and perpetuating these quotas. E. Tariffs and Quotas Compared: The primary difference between tariffs and quotas is the revenues. Revenues from tariffs go to the government; revenues from quotas go to whomever secures the right to sell foreign goods in U.S. markets. If quota rights accrue to foreigners, then the domestic economy is worse off with a quota than with a tariff. F. Other Trade Restrictions : Export subsidies, low-interest loans to foreign buyers, domestic content requirements restrict free trade. III. Efforts to Reduce Trade Barriers A. Freer Trade by Multilateral Agreement
- General Agreement on Tariffs and Trade (GATT): An international trade treaty adopted in 1947 that resulted in a series of negotiated “rounds” aimed at freer trade.
- Dumping: Selling a commodity abroad for less than is charged in the home market or less than the cost of production. B. The World Trade Organization: (WTO) The legal and institutional foundation for world trade. C. Common Markets : Free trade agreements among countries, such as the European Union and NAFTA. IV. Arguments for Trade Restrictions: These arguments support domestic producers but lead to a loss in social welfare. Some make more sense than others A. National Defense Argument : Protection from import competition because domestic output is vital for national defense. B. Infant Industry Argument : Protection for emerging domestic industries from foreign competition. C. Antidumping Argument : Foreign competitors should not be allowed to sell in this country for less than the cost of production or less than they charge in their home countries. D. Jobs and Income Argument : Restrictions protect domestic jobs and wage levels. E. Declining Industries Argument : Trade protection can help lessen shocks to the economy and allow for orderly transition to a new industrial mix. F. Problems with Trade Protection :
- Protecting one stage of production may require protecting downstream stages.
- The cost of protection includes the resulting welfare loss AND the cost of resources used to seek protection.
- The transaction costs of enforcing the myriad restrictions.
- Economies isolated from foreign competition become less innovative and less efficient.
- Other countries usually retaliate.
- Which is true under conditions of pure competition? A. There are differentiated products. B. The market demand curve is perfectly elastic. C. No single firm can influence the market price by changing its output. D. Firms that cannot make pure or economic profits go bankrupt.
- In a perfectly competitive market, the demand curve faced by an individual firm is: A. perfectly inelastic. B. relatively inelastic. C. perfectly elastic. D. relatively elastic.
- Suppose there are 50 firms in a perfectly competitive market and each maximizes profit at 50 units of output when market price is $15.00 per unit. One of the points on the market supply curve must be at: A. price = $15 and quantity supplied = 2,500. B. price = $15 and quantity supplied = 25,000. C. price = $3.33 and quantity supplied = 2,500. D. price = $3.33 and quantity supplied = 25,000.
- To maximize profits, a perfectly competitive firm should produce where marginal: A. cost equals total revenue. B. cost exceeds marginal revenue. C. cost equals marginal revenue. D. revenue exceeds marginal cost.
- As long as marginal cost is below marginal revenue, a perfectly competitive firm should: A. increase production. B. hold production constant. C. decrease production. D. reconsider past production decisions.
- A perfectly competitive firm facing a price of $50 decides to produce 500 widgets. Its marginal cost of producing the last widget is $50. If the firm's goal is maximize profit, it should: A. produce more widgets. B. produce fewer widgets. C. continue producing 500 widgets. D. shut down.
- A perfectly competitive firm in the long run: A. will earn positive or negative economic profits. B. will earn negative accounting profits as long as economic profits are positive. C. makes zero economic profits. D. makes zero accounting profits.
- Suppose that the firms in the perfectly competitive oat industry currently are receiving a price of $2 per bushel for their product. The minimum possible average total cost of producing oats in the long run is $1 per bushel. It follows that: A. the oat industry is in equilibrium. B. new firms will enter the oat industry. C. the price of oats will remain at $2 per bushel in the long run. D. firms in the oat industry will earn economic profits in both the long run and the short run.
- Refer to the graph shown. What area represents total economic profits? A. DAFM B. CBWT C. MFWT D. DABC
- Refer to the graph shown. Which graph depicts a perfectly competitive firm in long-run equilibrium? A. graph I B. graph II C. graph III D. graph IV
- Refer to the graph shown. Which graph depicts a perfectly competitive firm that will shut down? A. graph I B. graph II C. graph III D. graph IV
- Assume a purely competitive increasing-cost industry is in long-run equilibrium. Now suppose that an increase in consumer demand occurs. After all the resulting adjustments have been completed, the new equilibrium price: A. and industry output will be less than the initial price and output. B. and industry output will be greater than the initial price and output. C. will be greater, but the new output will be less than initially. D. will be less, but the new output will be greater than initially.
- Productive efficiency refers to: A. cost minimization, where P = minimum ATC. B. production, where P = MC. C. maximizing profits by producing where MR = MC. D. setting TR = TC.
