Super Microeconomics Prep

These notes are based on the Principles of Microeconomics 3e. You can find this textbook here.

Chapter 1

Economics: Derived from Greek “Oikonomos” meaning “management of the household”

True Def: the study of how humans make decisions in the face of scarcity, from individual decisions to societal decisions

A Good Economic Theory: captures the essence of the economic concepts and facilitates their understanding.

Scarcity: Human wants for goods/services/resources exceeds what is available.

DIvision of Labor: The way in which different workers divide required tasks to produce a good/service

Allows greater production (quantity of output)

Specialization: When workers/firms focus on particular tasks for which they were well-suited within the overall production process

Allowed businesses to take advantage of economies of scale (for many goods, as the level of production increases, the average cost of producing each individual unit decreases).

Macro vs. Micro: Microeconomics looks through the world through a microscope (ex: individual markets for goods and services) while macroeconomics looks at the world through the window of an airplane (ex: broad trends in the economy)

Macro focuses on broad issues (growth, unemployment, inflation, trade balance) while Micro focuses on the actions of individuals within the economy (households, workers, businesses)

Rising Gas Prices:

Micro Analysis: WHat’ll happen to the cost of shipping goods?
Macro Analysis: What will happen to the growth and employment across all sectors of the economy?

Monetary Policy: involves altering the level of interst rates/the availability of credit in the economy/ the extent of borrowing. This is usually determined by a nation’s central bank.

Fiscal Policy: economic policies that involve government spending/taxes. This is usually determined by a nation’s legislature.

John Maynard Keynes: thought that economics teaches you how, not what, to think.

Microeconomic Questions:

What should be produced?

Who should produce?

What should be consumed?

How much should be consumed?

What should the price be and how is it determined?

Economic Systems:

Traditional Economy: an agricultural economy where things are done the same as they’ve always been done. It’s the oldest economic system with occupations staying in the family. What you produce is what you consume, and there’s little economic progress or development.

Command System: An economy that relies solely on a central plan to allocate government-owned property resources (North Kora, Cuba). The government decides what goods/services will be produced and what prices it will charge, as well as what methods of production to use + how much to pay workers. The government prodices many necessities for free (healthcare, education)

Market System: An economy that is characterized by the private ownership of resources and the use of markets and prices to coordinate/direct economic activities (efficiency, incentives, freedom).

In the real world, most economies are mixed, combining elements of all 3 systems.

Market: interaction between potential buyers and sellers; a combination of demand and supply.

Private Enterprise: individuals or groups of private individuals own and operate the means of production (resources and business).

Model: A simplified representation of a real situation used to betetr understand real-life situations + tet out theories (a simplified representation of how two+ variables interact with each other)

Real but simplified economy or simulating an economy on a computer

“Other Things Equal” Assumption: all other relevant factors remain unchanged (ceteris paribus)

Circular Flow Diagram: Shows how households and firms interact in the goods/services market, and in the labor market.

In the Goods and Services Market: firms sell, households pay. In the labor market: households provide and firms pay w/ wages, salaries, and benefits

Household: A person or group of people that share their income

Firm: An organization that produces goods and services for sale. They sell these goods/services to households in markets for goods and services.

Firms buy the resources the need to produce (factors of production - land, labor, capital and entrepreneurial ability) in Factor Markets.

Rules: There’s no such thing as an absolutely free market. Regulation always defines the “rules of the game” in an economy. Market-oriented economies generally have less regulation (only regulating to maintain an even playing field), while heavily regulated economies often have underground economies (black markets - markets where buyers and sellers make transactions withut the govenrment’s approval).

Globalization: where buying and selling in markets have increasingly crossed national borders (measured through the high levels of trade and exchange between countries)

Exports: the goods/services that a nation produces domestically and sells abroad

Imports: the goods/services that are produced abroad and sold domestically

GDP (Gross Domestic Product): measures the size/value of total production in an economy

Chapter 2

Budget Constraint: indicates all the combinations of 2 goods that can be afforded, given the budget amount and the price of the goods.

Equation: Budget = P1 x Q1 + P2 x Q2, where P and Q are the price and quantity of the items purchased, and Budget is the amount of income one has to spend.

All decisions involve what will happen next (what quantities of goods will be consumed, how many hors will be worked, how much will be saved) and do not focus on past choice -> sunk costs shouldn’t affect the current decision

Despite only having two goods, which isn’t that realistic (in a modern economy, people choose from thousands), you can draw multiple of these constraints to show the possibletradeoffs betwee many different pairs of goods -> every choice has an opportunity cost.

Opportunity Cost: What people must give up to obtain what they desire (the cost of one item is the lost opportunity to do or consume something else - watch movies instead of sleep)

Calculating Opportunity Cost: Let G1 = Good 1, G2 = Good 2

Producing 1 of G1 costs you # of G2/# of G1
Producing 1 of G2 costs you # of G1/ # of G2

Marginal Analysis: examining the benefits and costs of choosing a little more or a little less of a good (comparing how costs and benefits change from one option to another)

Utility: the importance that goods/services provide

Law of Diminishing Marginal Utility: as a person receives more of a good, the additional (marginal) utility from each additional unit of the good declines (ex: the first slice of pizza brings more satisfaction than the 6th)

Explains why people/societies rarely make all-or-nothing choices

Sunk Costs: costs that were incurred in the past and cannot be recovered. Dealing with these are annoying -> requires admitting an earlier error in judgement, but the point is to ignore them and make decisions based on what will happen in the future.

Production Possibilities Frontier (PPF): shows the tradeoffs between dividing desired resources between different goods/services.

The slope of this line shows the opportunity cost!!

There are more similarities than differences between individual and social choice. That’s jsit good to know.

PPF vs. Budget Constraint:

The budget constraint is a straight line (its slope is given by the relative prices of the two goods), while the PPF has a curved shape bc of the Law of Diminishing Returns. Plus, the PPF has no specific numbers on the axes, because we don’t know the exact amount of resources.

Law of Increasing Opportunity Cost: as production of a good/services increases, the marginal opportunity cost of producing it increases as well

Productive Efficiency: given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity of the production of another good. These take time to implement and discover, and economic growth is gradual -> as a result, society must choose between tradeoffs in the present.

Allocative Efficiency: The particular combination of goods/services on the production possibility curve that a society produces represents the combination that society most desires

To determine what society desires, you gotta look at a variety of factors. But at its core, allocative efficiency means producers supply the quantity of each product that consumers demand, and only one of the productively efficient choices will be the allocatively efficient choice for society as whole.

Comparative vs. Absolute Advantage: When a country can produce a good at a lower opportunity cost than another country vs. when a country can produce more of a good.

An Economic Approach to Decision Making: can be useful but is not how people, firms, and society act. When thinking about the economic actions of these groups, it is reasonable to analyze them with the tools of economic analysis.

Economics seeks to describe economic behavior as it actually exists, and it mostly depicts people as self-interested, despite this being immoral behavior. Self-interestedness can just be personal choice and freedom, too.

Positive Statements: Describe the world as it is - factual

Normative Statements: Describe how the world should be - subjective and based on opinion

Invisible Hand: broader social good can emerge from selfish individual actions.

Chapter 3

Demand: refers to the amount of good/service that consumers are willing and able to purchase at esach price. It’s based on needs and wants which, to an economist, are the same thing. It’s also based on the ability to pay (aka no license == no demand for a car)

Refers to the demand curve/schedule as a whole

Price: what a buyer pays for a unit of that specific good/service OR what a producer receives for selling one unit of a good or service

Law of Demand: Rise in price == quantity demanded decreases, and vise versa. This assumes that all other variables that affect demand are constant.

Quantity Demanded: total num of units a consumer would purchase at that price.

Refers to one point/value on the demand curve/schedule

Demand Schedule: a table that shows the quantity demanded at each price

Demand Curve: the relationship between price and quantity demanded on a graph (quantity on horizontal axis)

Different for each product: may be steep, flat, or curved, but nearly are are sloping down from left to right, embodying the law of demand (as price increases, the quantity demanded decreases)

Supply: the amount of some good/service a proeucer is willing to supply at each price

Quantity Supplied: total number of units a producer would provide at that price.

Law of Supply: a higher price leads to a higher quantity supplied and a lower price leads to a lower quantity supplied

Supply Schedule: a table that shows the quantity supplied at a range of different prices

Supply Curve: a graph that shows the relationship between price (vertical) and quantity (horizontal axis)

Nearly all supply curves slope up from left to right, illustrating the law of supply (as the price rises, the quantity supplied increases, and vise versa)

Equilibrium:

the point where the supply and demand curve cross.

Equilibrium Price: the only price where the plans of consumers and producers agree -> quantity demanded (amt of the product consumers want to buy) is equal to the quantity supplied (the amount producers want to sell). This common quantity is named the equilibrium quantity.

If a market isn’t at this equilibrium, economic pressures arise to move the market toward the equilibrium price/quantity.

Above Equilibrium Price: Quantity supplied exceeds the quantity demanded -> excess supply (surplus)

Ex: gasoline would start to accumulate, and if this surplus remains unsold, some producers/sellers would wanan cut prices (better to sell at a lower price than not sell at all), and others would follow to avoid losing sales.This would stimulate a higher quantity demanded.

TLDR: if the price is above equilibrium, incentives built into the supply/demand structure will create pressures for the price to fall toward the equilibrium.

Below Equilibrium Price: quantity demanded exceeds the quantity supplied -> excess demand (shortage)

Ex: stations would run short on fuel, and oil companies would recognize this lucrative business, sel gasoline at a higher price to make more money -> price rises towards equilibrium level!!

Ceteris Paribus Assumption: “other things being equal” - all other variables are held constant. This assumption is used on any given demand or supply curve.

We apply this when we observe how changes in price affect demand or supply

Factors (other than price) that Affect Demand:

Income: with higher incomes, the quantity demanded increases, causing the demand curve to shift to the right, indicating an increase in demand. With lower incomes, the quantity demanded decreases at any given price, shifting the demand curve to the left -> at any given price, the quantity demanded is now lower, indicating a decrease in demand.

Normal Good: A product whose demand rises when income rises/ whose demand falls when income falls (ex: name brand)
Inferior Good: a product whose demand falls when income rises (ex: generic brand)

Changing Tastes or Preferences

Changes in the Composition of the Population

Changes in the Prices of Related Goods

Substitute: a good/service we can use in place of another good/service (ebooks vs. traditional books)
Complements: goods that we use together (cereal and milk)

Changes in Expectations about Future Prices/Other Factors that Affect Demand

Factors of Production/Inputs: combinations of labor,materials, and machinery that a firm uses to produce goods and services. Lower costs of production == profits go up and firm motivated to increase output, causing a firm to supply a larger quantity at any given price for its output (aka as costs go down, quantity supplied increases and supply curve moves to the right)

Four Step Process to find Changes in Equilibrium Price and Quantity:

Draw Supply and Demand model before the economic change took place. We need: the law of demand (tells us the slope of demand curve is negative), the law of supply (the slopeof the supply curve is positive), the shift variables for demand, and the shift variables for supply. Find the initial equilibrium values for price and quantity.

Decide whether the economic change affects demand or supply (does the event refer to something in the demand list or supply list of factors?)

Decide whether the effect on demand/supply causes the curve to shift to the left or right, thne sketch the new curve on the diagram (does the event increase or decrease the amount consumers want to buy/producers want to sell)?

Identify the new equilibrium, then compare the original equilibrium price/quantity to the new one.

Price Controls: laws that governments enact to regulate prices

Price Ceiling: keeps a price from rising above a certain level (“ceiling”) - legal maximum price one pays for some good/service, in order to keep the price of some necessary good/service affordable

Enacted in an attempt to keep prices low for those who need the product. But when the market price isn’t allowed to rise to equilibrium level, quantity demanded > quantity supplied, and a shortage occurs. We know what happens then.

Price Floor: keeps a price from falling below a certail level (“floor”) - legal minimum price one pays for some good/service.

Consumer Surplus: the amount that individuals would have been willing to pay minus the amount they actually paid. It’s the area above the market price and below the demand curve.

Producer Surplus:

The extra benefit producers receive from selling a good or service (the price the producer actually received minus the price the producer would’ve been willing to accept). It’s the area between the market price and the segment of the supply curve below the equilibrium.

Social/Economic/Total Surplus: The Sum of consumer surplus and producer surplus. It’s larget at equilibrium quantity and price than any other quantity, demonstrating the economic efficiency of the market equilibrium. At that level of output, it’s impossible to produce greater consumer surplus without reducing producer surplus, and vise versa.

Along with creating inefficiency, price floors and ceilings will also transfer some consumer surplus to producers, or some producer surplus to consumers.

Deadweight Loss: the loss in social surplus that occurs when the economy produces at an inefficient quantity. When this exists, it’s possible for both consumer and producer surplus to be higher, because the price control is blocking some suppliers and demanders from transaction they’d both be willing to make.

Chapter 19

Absolute Advantage: When one country can use fewer resources to produce a good compared to another country -> more productive than another country

In high-income countries w/ well-educated workers, technologically advanced equipment, and the most up-to-date production processes, they can produce all products with fewer resources than low-income countries. However, they and their trading partners can still benefit from trade.

Comparative Advantage: when a country can produce more goods at a lower opportunity cost in terms of other goods

Elastic Advantage: when a product’s demand is highly responsive to changes in price - small change in price == large change in demand

If a Post-trade Consumption Point is beyond the PPF, the country has gained from trade (consuming more than it can produce as a result of specialization and trade)

Trade comes from specializing in one’s comparative advantage - taking advantage of lower

opportunity costs in the other country

Theory of Comparative Advantage: trade should happen between economies with large differences in opportunity costs of production.

Intra-Industry Trade: International trade of goods within the same industry, due to the division of labor leading to learning, innovation, and unique slills, and economies of scale.

Comparative advantage is not fixed as taking advantage of economies of scale plays a larger role in productivity than geography/edcuation levels

Countries can specialize in unique processes and skills

They keep costs low collectively, while giving consumers lots of options to choose from

Because they work on very specific/particular products, firms in certain countries can develop unique and different skills.

This differs from economies of scale, which seek to otehrwise promote fewer firms and fewer product options

Splitting Up the Value Chain: splitting the different stages of producing a good in different geographic locations.

International Trade provides a way to combine the lower average production costs that come from economies of scal eand still haev competition and variety for comsumers.

Tariffs: taxes that governments place on imported goods, traditionally used simply as a political tool to protected certain vested economic/social/cultural interests. Now, the WTO (World Trade Organization) seeks to lower barriers to international trade by reducing tariffs.

Low-income Countries Benefit More from trade than High-income Countries. But:

Even a small gain is enough money to desert attention/ these gains would continue to persist with every year of trade

Estimates of gains may be low because stome of the gains from trade are not measured well in economic statistics

Chapter 5

Elasticity: measures responsiveness of one variable to changes in another variable

Price Elasticity: ratio between percent change in quantity demanded/supply demanded and the corresponding percent change in price.

Of Demand: percent change in quantity demanded/percent change in price
Of Supply: percent change in quantity supplied/percent change in price

Elastic Demand/Supply: where the elasticity is greater than 1 -> high responsiveness to changes in price.

Inelastic Demand/Supply: when less than one -> low responsiveness to price changes

Unitary Elasticities: proportional responsiveness of either demand or supply -> % change in quantity/supply == % change in price

Midpoint Method for Elasticity: used to calculate elasticity along a demand/supply curve, using the average percent change in both quantity and price

ExTrEmE Elasticity:

Perfect/infinite Elasticity: when the quantity demanded/supplied changes by an infinite amount in response to any change in price at all. This happens when the supply curve is completely flat.

Zero/Perfect Inelasticity: when a percentage change in price results in zero change of quantity. This happens when the curve is completely vertical.

Constant Unitary Elasticity: when a price change of one percent results in a quantity change of one percent -> elasticity == 1. It’s really steep at the beginning and approaches zero as you keep increasing the quantity (demand curve), while in a supply curve, it’s linear.

The demand for necessities is normally inelastic, white items that aren’t necessities are more price-sensitive.

Supply/demand are often inelastic in the short run, so shifts in either demand/supply can cause a great change in prices. They become more elastic in the long run, so the movement in prices are muted while quantity adjusts more easily.

Income Elasticity of Demand: percent change in quantity demanded/percent change in income

This value is mostly positive (rise in income == more quantity demanded -> normal goods). But when it’s negative (rise in income == less demand) we call this an inferior good.

Cross-Price Elasticity of Demand: the percent change in the quantity of good A that’s demanded/ percent change in the price of good B.

Complement goods (Oreos and Milk -> things that go together) have negative values because a higher price of Milk -> lower quantity consumed of Oreos.

Substitute Goods (Orange and Mango juice -> things that can substitute) have positive values because a higher price for orange juice would drive greater demand for mango.

Wage Elasticity of Labor Supply: percent change in hours worked/percent change in interest rate (for teens, this value is elastic -> percent change in wages leads to larger percent change in hours worked. For adult workers, it’s more inelastic -> percent change in wages leads to lesser of a percent change in hours worked).

Elasticity of Savings: describes shape of supply curve for financial capital -> percent change in quantity of savings/ percent change in interest rate

Chapter 4

Salary/Wage: price in the labor market. Higher prices == decrease in the quantity of labor demanded by employers, and vise versa (lower salaries == more labor demanded)

At equilibrium: every employer who wants a worker can find one, and every worker who wants a job at equilibrium salary can get one. When not at equilibrium, economic incentives tend to move salaries towards the equilibrium.

Labor Market: the term that economists use for all the different markets for labor. If there’s excess labor supply as a result of high salary, employers will have an incentive to offer lower wages. This would move salaries down to equilibrium.

Has supply and demand curves, with the demand labor curve being a downward sloping function of the wage rate. The market demand for labor == horizontal sum of all firms’ demands for labor.

The supply of labor curve is an upward sloping function of the wage rate, while the market supply of labor is the horizontal summation of all individuals’ supplies of labor.

Things that Increase the demand for labor:

As the Demand for Goods Increases: the demand for labor increases, to meet employers’ production requirements.

As Education/Training of laborers increase: the demand for that labor increases, too.

As the number of companies producing a given product increases

Complying with Government regulations: this can increase or decrease the labor demand.

If prices of other inputs fall, production becomes more profitable and suppliers will demand more labor.

More workers == increased labor force, shifting supply curve to the right.

More education required == labor force would decrease. For example, the number of PHD people is much less than the number of high school graduates.

More government policies == may set higher qualifications for certian jobs, or may lower qualifications instead. This can decrease/increase the supply of labor, respectively.

Minimum Wage: a price floor that makes it illegal for employers to pay their laborers below the price. Some states argue for a living wage (a higher minimum wage that’ll ensure a reasonable standard of living).

Supplying Financial Capital: saving, Demanding Financial Capital: receiving funds

Interest Rate: a rate of return. Higher rates of return == decrease in quantity demanded (as interest rate rises, consumers will reduce the quantity that they borrow. But more firms will be eager to issue credit cards).

Intertemporal Decision making: people making investment or savings decisions across a period of time.

Usury Laws: impose an upper limit on the interest rate that lenders can change. In many cases, these upper limits are well above the market interest rate.

Rules of Labor Markets:

If a firm wants to maximize profits, it will never pay more for a worker than the value of their marginal productivity to the firm (first rule of labor markets)

Ex: a worker makes 2 objects per hour, each object sells for 4 dollars,

Perfectly Competitive Labor Market: firms can hire all the labor they want at the going market wage, because neither suppliers nor demanders of labor have any market power.

The Going Market Wage Rate is determined by the interaction of supply and demand in the labor market.

Chapter 14

Affirmative Action: giving special rights to minorities in the case of hiring, promotion, access to education, in order to make up for past discrimination.

Bilateral Monopoly: a labor market with a monopsony on the demand side and a union on the supply side. Both sides have monopoly power, so the equilibrium level of employment will be lower than that for a competitive labor market, but the equilibrium wage will differ based on the side that negotiates better.

Higher wage: union wins, Lower wage: monopsony wins.

Collective Bargaining: negotiations between unions and a firm/firms.

Discrimination: actions based on the belief of inferiority on the basis of race, gender, or religion.

Black/female workers earn less on average. This can be fixed through a range of public policies (requiring equal pay for work, attaining more equal educational outcomes)

Free markets can allow this to happen, but the threat of a loss of sales/productive workers can influence a firm not to discriminate.

Monopsony: a labor market with only one employer (basically, a huge conglomerate that dominates one industry)

Can pay any wages it chooses, subject to the market supply of labor. Too low == not enough workers. So salaries must be high enough to the point where the marginal cost of labor == the labor demand.

Result: lower level of employment than competitive labor market, but also lower equilibrium wage.

Labor Union: organization of workers that negotiates as a group with employers over compensation and work conditions. Members are normally paid more on average than other workers, so they must be more productive or the higher pay will lead employers to find ways of hiring fewer union workers than normal.

Labor union membership falling because: shift of jobs to service industries, greater competition from globalization, worker-friendly legislation, U.S. laws that are less favorable to organizing unions.

Immigration is: historically high when measured in absolute numbers, but not if we measure it as a share of population. US economic gains exist but aren’t very high.

Immigration causes slightly lower wages for low-skill workers and budget problems for certain state/local governments.

Chapter 7

Accounting profit: total revenues - explicit costs (depreciation)

Economic Profit: total revenues - (implicit AND explicit costs)

Average profit (profit margin): profit / quantity of output produced

Average total cost: total cost / quantity of output

Average variable cost: variable cost/ quantity of output. Typically U-shaped on a graph.

If a firm’s average variable cost of production is lower than the market price, then the firm would be earning profits if fixed costs are left out of the picture.

Constant return to scale: expanding all inputs proportionately does not change the average cost of production -> average cost does not change as output increases

Diminishing marginal productivity: as a firm employs more labor, the amount of additional output produced declines -> the additional output obtained is less than for the previous increment to labor.

Diseconomies of scale: the long-run average cost of producing output tends to increase as total output increases.

Economic profit: total revenues - total costs (aka explicit + implicit costs)

Economies of scale: the long-run average cost of producing output decreases as total output increases.

Explicit costs: out-of-pocket costs for a firm (payments for wages and salaries, rent, materials)

Factors of production/inputs: resources that firms use to produce their products (ex: labor, capital)

Firm: an organization that combines inputs of labor, capital, land, raw/finished component materials to produce outputs.

Fixed costs: cost of the fixed inputs; expenditure that a firm must make before production starts and that does not change regardless of the production level. This is for the short term, and these are sunk costs (are in the past, and cannot be altered by the firm so they shouldn’t pay any role in economic decisions about future production or pricing)

Fixed inputs: factors of production that can’t be easily increased or decreased in a short period of time

Implicit costs: opportunity cost of resources already owned by the firm and used in business

Ex: expanding a factory onto land already owned

Long run: period of time where all of a firm’s inputs are variable. There are no diminishing returns. Firms can choose the optimal capital stock.

Long-run average cost curve: shows the lowest possible average cost of production, allowing all the inputs to production to vary so that the firm is choosing its production technology.

Downward sloping: economies of scale

Flat: constant return to scale

Upward sloping: diseconomies of scale

If only one quantity produced that results in the lowest possible average cost, then all of the competing firms of an industry are roughly the same size.

If the LRAC has a flat segment at the bottom, then the firms will display a variety of sizes c a firm can produce a range of diff quantities at the lowest average cost.

Marginal cost: the additional cost of producing one more unit (MC = ∆TC|∆L -> change in total cost divided by the change in output). These typically rise.

To find whether the marginal unit of a product is adding to profit, a firm can compare marginal cost to the additional revenue it gains from selling another unit of product.

Marginal product: change in a firm’s output when it employees more labor (MP = ∆TP|∆L) -> the slope of the total product curve.

Private enterprise: the ownership of business by private individuals

Production: combining inputs to make outputs. Hopefully, output value > inputs.

You can’t vary fixed inputs (capital) in a short period of time, so the only way to change output in the short run is to change the variable inputs (ex: labor)

For every input, there’s an associated factor payment (labors have wages and salaries).

The cost of production for a given quantity of output == the sum of the amount of each input required to produce that quantity of output * the associated factor payment

Production function: mathematical equation that tells how much output a firm can produce with given amounts of the inputs.

Production technologies: alternative methods of combining inputs to produce output

Revenue: income from selling a firm’s product (price x quantity sold)

Short run: period of time during which at least one or more of the firm’s inputs is fixed

Short run average cost curve: the average total cost curve in the short term, showing the total of the average fixed costs and the average variable costs

Total cost: the sum of fixed and variable costs of production

Total product: firm’s output

Variable cost: cost of production that increases with the quantity produced (the cost of the variable inputs)

Variable inputs: factors of production that a firm can easily increase/decrease in a short period of time

Chapter 8

Perfect competition: each firm faces many competitors that sell identical products

Characteristics:

Thousands of sellers
Easy entry/exiting of firms
Identical products
Sellers are price takers

Short-run production period: when firms are producing with some fixed inputs.

A Perfectly Competitive Firm is a price taker: a firm in a perfectly competitive market that must take the prevailing market price as given

If it attempts to charge even a tiny amount more than the market price, it won’t make any sales

Its total revenue steadily increases at a constant rate determined by the market price as the quantity of output increases.

Highest Profits when total revenues > total costs by the greatest amount of output, or when marginal revenue == marginal cost.

If Market Price is Above Average Cost at Profit-maximizing Output Quantity: the firm is profiting! If it’s below, the firm is losing money. If it’s equal, the firm is making zero profits -> zero profit point

Marginal revenue: the additional revenue gained from selling one more unit

If the market price faced by a perfectly competitive firm > average variable cost (AVC) BUT below average cost (AC), the firm should keep producing in the short run but exit in the long run.

Shutdown point: level of output where the marginal cost curve intersects the average variable cost curve at the minimum point of AVC

If the price is below this point, the firm should shut down immediately.

Break even point: level of output where the marginal cost curve intersects the average cost curve at the minimum point of AC

If the price is at this point, the firm is earning zero economic profits.

Entry: the long-run process of firms entering an industry in response to industry profits

Exit: the long run process of firms reducing production and shutting down in response to industry losses

Long-run equilibrium: where all firms earn zero economic profits producing the output level where:

P = MR = MC and P = AC

Two Important Conditions:

Allocative Efficiency:
Productive Efficiency:
Implications: resources are allocated to their best alternative use, and they provide the maximum satisfaction attainable by society

Market structure: the conditions in an industry (# of sellers, difficulty for a new firm to enter, type of products that are sold)

Chapter 10

Monopolistic competition: a market where many firms compete to sell similar but differentiated products

Differentiated == characteristics of the good or service, locations from where it’s sold, intangible aspects of the product, perceptions of the product

The perceived demand curve is downward-sloping (it is a price maker and chooses a combination of price and quantity). It’s also more elastic than the perceived demand curve for a monopolist because the monopolistic competitor has direct competition unlike the pure monopolist

A profit-maximizing monopolistic competitor will find the quantity where MR = MC, and then will produce that level of output and charge the price that the demand curve indicates.

If economic profits are being earned, the industry will attract entry until profits are driven to 0 in the long run.

If losses, then there’s gonna be exit of firms until economic losses are driven up to 0 in the long run

NOT PRODUCTIVELY EFFICIENT (doesn’t produce at the minimum of its Avg Cost curve), NOT ALLOCATIVELY EFFICIENT (produces where P>MC rather than P=MC) -> a monopolistic firm will produce a lower quantity at a higher cost and charge a higher price than a perfectly competitive firm

Benefits: greater variety, incentives for improved products and services. Maybe too much variety?

Cartel: a group of firms that collude to produce the monopoly output and sell at the monopoly price

Collusion: when firms act together to reduce output and keep prices high

Differentiated product: a product that consumers perceive as distinctive in some way

Duopoly: an oligopoly with only two firms

Game theory: a branch of mathematics that economists use to analyze situations in which players must make decisions and then receive payfoffs based on what decisions the other players make

Imperfectly competitive: firms and organizations that fall between the extremes of monopoly and perfect competition

Kinked demand curve: a perceived demand curve that arises when competing oligopoly firms commit to match price cuts but not price increases

Oligopoly: when a few large firms have all or most of the sales in an industry.

Highest profits are earned if they can become a cartel and act like monopolistic competitors by reducing output and raising prices. It’s illegal, for one, and it breaks down as each member of the oligopoly can benefit individually from expanding output

Prisoner’s dilemma: a game where the gains from cooperation are larger than the rewards from self-interest. What’s good for all of us is good for each of us.

Product differentiation: any action that firms do to make consumers think their products are different from their competitors

Chapter 9

Allocative efficiency: producing the optimal quantity of some output/ the quantity where the marginal benefit to society of one more unit == marginal cost (P = MC)

Productive Efficiency: producing at the minimum of the average cost curve (P = AC)

Barriers to entry: the legal/technological/market forces that may discourage or prevent potential competitors from entering a market

Economies of scale that lead to natural monopoly

Control of a physical resource

Legal restrictions on competition

Patent, trademark, and copyright protection

Predatory pricing and other intimidating practices

copyright: a form of legal protection to prevent copying, for commercial (selling) purposes, original works (books, music, etc)

deregulation: removing government controls and regulations over setting prices and quantities in certain industries.

Intellectual property: the body of law that protects the right of inventors to produce and sell their inventions (patents, trademarks, copyrights, trade secret law). Basically, legally guaranteed ownership of an idea.

Legal monopoly: legal prohibition against competition (regulated monopolies, intellectual property protection)

Marginal profit: profit of one more unit of output (marginal revenue - marginal cost)

monopoly: where one firm controls the market by being the only producer of all the outputs.

Monopolist: not a price taker bc it determines the market price by deciding what quantity to produce. Total revenue is low at low quantities (not selling much) of output and at very high quantities (very high quantity will only sell at a low price) of output

Total revenue will start low, rise, and then decline, and the marginal revenue will decline too, as each additional unit will push down the overall market price

The monopolist will select the profit-maximizing level of output where MR = MC, and then charge the price for that quantity of output

Not productively efficient because they don’t produce at the minimum of the average cost curve. They're not allocatively efficient either. So, they produce less at a higher average cost and charge a higher price than that of a competitive industry. They may also lack incentives for innovation. In conclusion, they suck.

Natural monopoly: economic conditions in the industry (economies of scale or control of a critical resource) that limit effective competition (no other firm can enter without a cost disadvantage)

patent: a government rule that gives the inventor the exclusive right to make, use, or sell the invention for a limited time.

Predatory pricing: when an existing firm uses sharp, temporary price cuts to discourage or eliminate existing competition, and then raising prices again

Trade secrets: methods of production kept secret by the producing firm

Trademark: an identifying symbol or name for a particular good and can only be used by the firm that registered the trademark.

Chapter 11

When Two Formerly Independent Firms become One:

Acquisition: when one firm purchases another

Merger: when two formerly separate firms combine to become a single firm

Antitrust laws: laws that give the government the power to block certain mergers or even break up large firms into smaller ones

They block authorities from openly colluding to for a cartel that’ll reduce output and raise prices. However, companies may try to subvert these restrictions, and as a result, some antitrust cases have restrictive practices that can reduce competition (tie-in sales, bundling, predatory pricing)

Bundling: where multiple products are sold as one

Concentration ratio: an early tool that measures what share of the total sales in the industry are accounted for by the largest firms

Used to measure the degree of monopoly power in an industry; normally, the top 4-8 firms

In Natural Monopolies: market competition doesn’t work well, so the government may want to regulate price and/or output (ex: public utilities)

Cost-plus regulation: when regulators permit a regulated firm to cover its costs and to make a normal level of profit

Exclusive dealing: an agreement that a dealer will sell only products from one manufacturer

To Measure Competition:

Four-firm concentration ratio: the percentage of the total sales in the industry that are accounted for by the largest four firms - one way of measuring the extent of competition in a market

Add the market shares together (the percentage of total sales) of the four largest firms

Herfindahl-Hirschman Index (HHI): an approach to measuring market concentration/competition by adding the square of the market share of each firm in the industry

Take the market shares of all firms in the market, square them, and then sum the total.

Market Share: the percentage of total sales in the market

Minimum Resale Price Maintenance Agreement: an agreement that requires a dealer who buys from a manufacturer to sell for at least a certain minimum price

Price Cap Regulation: when the regulator sets a price that a firm cannot exceed over the next few years

The firm can either earn high profits if it can produce at lower costs/sell a higher quantity than expected, or suffer low profits and losses if costs are high/sells less than expected

Regulatory Capture: when the supposedly regulated firms end up playing a large role in setting the regulations that they will follow and as a result, they “capture” the people usually through the promise of a job in that “regulated” industry once their term in government has ended

Restrictive Practices: practices that reduce competition but that do not involve outright agreements between firms to raise prices or to reduce the quantity produced

Tying Sales: a situation where a customer is allowed to buy one product only if the customer also buys another product

Chapter 12

Additional external cost: additional costs incurred by third parties outside the production process when a unit of output is produced

Countries are likely to make different choices about allocative efficiency (economic output vs. environmental production), but all countries should prioritize productive efficiency

Command-and-control regulation: laws that specify the max quantity of pollution and also details which pollution-control technologies one can/must use

Shortcomings:

No incentive for going beyond the limits set
Limited flexibility on where/how to reduce pollution
Often have politically motivated loopholes

Externality (spillover): a market exchange that affects an outside third party (aka “external” to the exchange)

Negative externality: when a third party suffers from a market transaction by others

If the parties imposing this negative externality had to account for the broader Social costs (costs including the private costs incurred by firms + additional costs incurred by third parties outside the production process (ex: pollution charges)), they’re incentivised to reduce the negative externality.

Positive externality: when a third party outside the transaction benefits from a market transaction by others

Markets would tend to underporduce output because suppliers aren’t aware of the additional demand from others
If the parties generating this positive externality would receive compensation for their efforts, they’d have an incentive to increase production of the positive externality.

International externalities: externalities that cross national borders and that a single nation acting alone can’t resolve

Ex: global warming, Biodiversity (the full spectrum of animal/plant genetic material)

Market failure: when the market on its own doesn’t allocate resources efficiently in a way that balances social costs and benefits (ex: externality)

Marketable permit program: a permit that allows a firm to emit a certain amount of pollution. Firms with more permits than pollution can sell the remaining permits to other firms

Cap and Trade Programs/ Market-Oriented Environmental Policies: used so that those who imposed negative externalities face the social cost

Property rights: the legal rights of ownership where others aren’t allowed to infringe on without paying compensation

Pollution charge: a tax imposed on the quantity of pollution emitted by a firm (pollution tax)

As environmental regulation increases, additional expenditures on environmental protection will probably have increasing marginal costs and decreasing marginal benefits -> flexibility/cost savings of market-oriented environmental policies will be more important

Chapter 13

External Benefits (Positive Externalities): beneficial spillovers to third parties, who didn’t purchase the good/service that provided the externalities.

New technology often has these positive externalities that benefit firms other than the innovator.

The social benefit of an invention typically exceeds the private benefit to the inventor.
If the inventor could receive a greater share of the social benefits for their work, they’d have greater incentive to seek out new inventions.

Free Rider: thos who want others to pay for the public good and then plan to use it themselves. Too many free riders == no public good provided.

Intellectual property: the body of law (patents, trademarks, copyrights, trade secret laws) that protect the right of inventors to produce and sell their inventions

They provide incentive for inventors, but they should be limited to genuinely new inventions + shouldn’t extend forever -> public policy with regard to technology must have a balance.

To Increase the Rate of Return for New Tech, Governments Can:

Directly fund research and development

Provide tax incentives for research and development

Protect intellectual property

Form cooperate relationships between universities and the private sector

Nonexcludable: when it’s costly or impossible to exclude someone from using the good, and, therefore, hard to charge for it

Nonrivalrous: when, despite one person using the good, others can use it too

Private benefits: the benefits a person who consumes a good/service recieves AKA a new product’s benefits or process that a company invests that the company captures

Private rates of return: when the estimated rates of return go to an individual (ex: interest on a savings account)

Public good: a good that is nonexcludable (costly or impossible for one user to exclude others from using it)) and non-rival (one person using the good doesn’t prevent others from using it)

This makes it dificult for market producers to sell to individual consumers, but also makes it so free riders may attempt to use the good without paying for it

To Overcome Free Riders:

Government actions
Social pressures
Specific situations where the market can collect payments

Social benefits: the sum of private and external benefits

Social rate of return: when the estimated rates of return go primarily to society (ex: free education)

Chapter 6

We assume that people seek the highest level of utility/satisfaction. Greater consumption == higher utility, but diminishing marginal utility exists.

To find utility-maximizing choice: add up total utility of each choice on the budget line and choose the highest total, choose random point and compare the marginal utility gains/losses of moving to nieghborhood points, compare the ratio of the marginal utility to price of good 1 w/ the marginal utility to price of good 2

MU/P1 = MU/P2

Behavioral economics: seeks to enrich the understanding of decision-making by integrating the insights of psychology and by investigating how given dollar amoujnts can mean different things to individuals depending on the situation.

Budget constraint/line: shows the possible combinations of two goods that are affordable given a consumers’ limited income

When income/price changes, a range of responses are possible:

Income rising == households demand higher quantity of normal/lower quantity of inferior goods
Price of good rising == households demand less of that good, but it depends on personal preferences
Higher price for one good == more/less demand of the other good

Traditional Theory ignores people’s state of mind or feelings, which can influence behavior (people tend to value a dollar lost more than a dollar gained) (many people over withhold their taxes, giving the government a free loan until they file their tax returns, so they’re more likely to get money back than have to pay money on taxes)

Consumer equilibrium: points on the budget line where the consumer gets the most satisfaction. This happens when the ratio of the prices of goods == ratio of marginal utilities.

Diminishing marginal utility: each marginal unit of a good consumed provides less of an addition to utility than the previous unit.

Fungible: units of a good (dollars, gold ounces, oil barrels) are capable of mutual substitution with each other and carry equal value to the individual.

Income effect: higher price == buying power of income reduced, even though actual income hasn’t changed. This always happens with a substitution effect.

Marginal utility: the additional utility provided by one additional unit of consumption

Per Dollar: the additional satisfaction guaranteed from purchasing a good given the price of the product - MU/Price

Substitution effect: when a price changes, consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price. This happens concurrently with an income effect.

Total Utility: satisfaction derived from consumer choices

Chapter 15

Earned Income Tax Credit (EITC): a method of assisting the working poor through the tax system

Effective Income Tax: percentage of total taxes paid divided by total income

Estate Tax: a tax imposed on the value of an inheritance

Income: a flow of money received (measured on a monthly/annual basis)

Income inequality: when one group receives a disproportionate share of total income or wealth than others

Lorenz Curve: a graph that compares the cumulative income actually received to a perfectly equal distribution of income. It shows that the share of population on the horizontal axis and the cumulative percentage of total income received on the vertical axis.

Medicaid: enacted in 1965, this federal-state joint program provides medical insurance for certain people with low income, including those near and below the poverty line, focusing on those with children, the elderly, and people with disabilities.

Poverty: the situation of being below a certain level of income one needs for a basic standard of living

Poverty line: the specific amount of income one requires for a basic standard of living

Poverty rate: percentage of a population living below the poverty line

Poverty trap: antipoverty programs so the government benefits decline substantially as people earn more income -> working provides little financial gain

Progressive Tax System: a tax system where the rich pay a higher percentage of their income in taxes rather than a higher absolute amount

Quintile: dividing a group into fifths, a method economists often use to look at distribution of income

Redistribution: taking income from those with higher incomes and providing income to those with lower incomes

Safety net: the group of government programs that provide assistance to people at or near the poverty line.

Supplemental Nutrition Assitance Program (SNAP): started in 1964, this federally funded program gives poor people SNAP cards they can use to buy food each month

Wealth: the sum of the value of all assets a person/company owns (money in bank accounts, financial investments, a pension fund, value of a home and other property)