econ101.txt

# Key concepts in Economics

* What is scarcity?

Our inability to satisfy all our wants.

* What does scarcity cause us to do?

Make choices.

* What is an incentive?

A reward that encourages an action, or a penalty that discourages an action.

* What is economics?

The social science that studies the choices that individuals, businesses,
governments, and societies make as they cope with scarcity, and the incentives
that influence and reconcile those choices.

* What is microeconomics?

The study of choices that individuals and businesses make, and how those choices
interact in markets; and the influence of governments.

* What is macroeconomics?

The study of the performance of the national and global economies.

* What are the two big economic questions?

1. How do choices end up determining what, how, and for whom goods and services
   are produced?
2. When do choices made in the pursuit of self-interest also promote the social interest?

* What are goods and services?

Objects that people value and produce to satisfy human wants.

* How does level-of-development affect what goods and services are produced?

Countries with a higher level of development tend to produce less agriculture
goods, proportionally.

* What is a Factor of production?

Resources that are used to produce goods and services.

* What are the 4 categories of factors of production?

1. Land
2. Labour
3. Capital
4. Entrepreneurship

* What is Land w.r.t factors of production?

"Gifts of Nature" that we use to produce goods and services.

* What is Labour w.r.t factors of production?

The work time and work effort that people devote to producing goods and services.

* What is Human Capital w.r.t factors of production?

The "quality" of labour, i.e. the knowledge and skill that people obtain from
education, training and experience.

* What is Capital w.r.t factors of production?

The tools, instruments, machines, buildings, and other constructions that
businesses use to produce goods and services.

* What is Entrepreneurship w.r.t factors of production?

The human resource that organizes land, labour and capital.

* What is self-interest w.r.t choices?

You make choices that are in your self-interest -- choices that you think
are best for you.

* What is social interest w.r.t choices?

Choices that are best for society as a whole are said to be in social interest.

* What are the two dimensions of social interest?

1. Efficiency
2. Equity

* When is a choice efficient?

If it is not possible to make someone better off without making someone else
worse off.

* When is a choice equitable?

Fairness, but economists have a variety of views about what is fair.

* What are the four topics that cause tension between self and social interest?

1. Globalization
    Economic crises can affect the whole world.
2. Information-age monopolies
3. Global warming
4. Economic instability

* What 6 ideas define the economic way of thinking?

1. A choice is a tradeoff.
2. People make rational choices by comparing benefits and costs.
3. A benefit is what your gain from something.
4. Cost is what you must give up to get something.
5. Most choices are "how-much" choices made at the margin.
6. Choices respond to incentives.

* What does "a choice is a tradeoff" mean?

Choices are an exchange between outcomes. Giving something up to get another
thing. Whatever you choose you could have chosen something else.

* What is a "rational choice"?

A choice that compares costs and benefits and achieves the greatest benefit
over cost for the person making the choice.

* What is a benefit?

The value that you gain.

* What is opportunity cost?

The cost of something is the highest-valued alternative that must be given up
to get it.

* What is the margin?

Most choices are not all or nothing, you can decide to dedicate only "half" of
something.

Costs and benefits change when you have more or less of something, you can
make your choice at the margin.

* What the "marginal benefit" and "marginal cost"?

MB: The benefit from pursuing an incremental increase in an activity.
MC: The opportunity cost of pursuing an incremental increase in an activity.

If MB > MC, then you should do more of the activity.

* How do choices respond to incentives?

Changing marginal cost or benefits changes the incentives we face and can lead
us to change our choice.

Idea: We can predict how choices will change by looking at changes in incentives.

* What can incentives be useful for?

Reconciling self-interests and social interests.

* What is a positive statement?

A statement that can be tested by checking it against facts.

"What is"

* What is a normative statement?

A statement that expresses an opinion and cannot be tested.

"What ought to be"

* What is an economic model?

A description of some aspect of the economic world that includes only those
features which are needed for the purpose at hand.

* How do economists test economic models?

By comparing predictions with the facts.

* What ways do economists validate their statements?

- Economic models
- Natural experiments
- Statistical investigations
- Economic experiments

* What is the production possibilities frontier?

A graph detailing what is possible for us to produce, given the resources
available to us.

* When is production efficient w.r.t the PPF graph?

When we are producing on a point that's on the PPF curve.

* When is production inefficient w.r.t the PPF graph?

When we are producing on a point that's inside the PPF curve, but not on the
curve.

* When is a production level attainable w.r.t the PFF graph?

When it's in the area under the curve.

* How does the PPF curve illustrate tradeoff?

The PPF curve illustrates how much production we need to decrease in one
product to increase production for another product.

* Why does opportunity cost increase as we produce more of a product?

Because resources are not equally productive in all activities.

* What does the outward bow of the PPF curve illustrate?

Increasing opportunity cost as production increases.

* What is the marginal cost?

The opportunity cost of producing one more unit of a product.

* How is preference measured?

Via marginal benefit and the maginal benefit curve.

* What is marginal benefit?

The benefit that one gains for consuming one more unit of a product. It is also
people's willingness to pay for one more of a product.

* What does a point on the marginal benefit curve mean?

How much of Y people are willing to give up (or pay) in order to get an X.

* When have we achieved production efficiency?

When we cannot produce more of any one good without giving up some other
good.

* When have we achieved allocative efficiency?

When we cannot produce more of any good that we value more highly, we have
achieved allocative efficiency.

* What is the point of allocative efficency on the PPF?

The point at which marginal benefit equals marginal cost.

* What is economic growth?

An expansion of production possibilities, an increase in the standard of living.

* What are the 2 key factors that influence economic growth?

1. Technological change
2. Capital accumulation

* What is technological change w.r.t economic growth?

The development of new and better ways of producing goods/services.

* What is capital accumulation w.r.t economic growth?

The growth of capital resources, including human capital.

* What is the cost of economic growth?

We must use resources to research and develop new capital, which means that we
must decrease our current production.

Opportunity cost: Less current consumption.

* What is the effect of economic growth on the PPF curve?

It expands rightwards.

* When does a person have a comparative advantage?

When one can perform an activity with lower opportunity cost than anyone else.

* When does a person have an absolute advantage?

When one is more productive than anyone else.

* Why is trading beneficial?

Because each people almost always have comparative advantages over each other,
they can specialize and trade with one another to maximize their production.

* What four social institutions have evolved to facilitate trade? Why?

1. Firms
2. Markets
3. Property rights
4. Money

To facilitate coordination between people.

* WHat are the two types of markets?

1. Factor markets
2. Goods markets

* How does money flow in the economy?

Households -> goods market -> firms -> factor markets -> households

* How do goods and services flow in the economy?

Firms -> goods market -> households -> factor markets -> firms

# Supply and demand

* What is a market?

Any arrangement that enables buyers and sellers to get information and do
business with each other.

* What is a competitive market?

A market that has many buyers and many sellers so no single buyer can influence
the price.

* What is the money price of a good?

The amount of money needed to buy it.

* What is the relative price of a good?

The ratio of the good's money price to the money price of the next best
alternative good.

It's opportunity cost.

* When do we consider that you demand something?

When you want it, can afford it, and have made a definite plan to buy it.

* What is quantity demanded?

The amount that consumers plan to buy during a particular time period and at
a particular price.

* What is demand?

The goods and services that consumers want.

* What is the law of demand?

Other things remaining the same, the higher the price, the lower the quantity
demanded.

* What are 2 causes of the law of demand?

1. Substitution effect
2. Income effect.

* What is the substitution effect?

When the relative price of a good/service rises, people seek substitutes for it,
decreasing the quantity demanded.

* What is the income effect?

When the price of a good/service rises relative to income, some people cannot
afford it anymore, decreasing the quantity demanded.

* What is the demand curve?

Price vs quantity demanded curve. Also called "willingness-to-pay-curve".

* What does willingness-to-pay measure?

Marginal benefit.

* What are the six factors that change demand?

1. Prices of related goods
2. Expected future prices
3. Income
4. Expected future income and credit
5. Population
6. Preferences

* What happens when demand increases?

The demand curve shifts rightwards.

* What happens when demand decreases?

The demand curve shifts leftwards.

* What is a substitute?

A good that can be used in place of another good.

* What is a complement?

A good that is used in conjunction with another good.

* What happens when the price of a good's substitute rises?

The demand of the good rises.

* What happens when the price of a good's complement rises?

The demand of the good falls.

* How do expected future prices affect demand?

When the price of a good is expected to rise, the current demand for the good
increases.

* What is a normal good?

A good for which demand increases as income increases.

* What is an inferior good?

A good for which demand decreases as income increases.

* What does an increase in demand do to the demand curve?

Shifts it to the right.

* What does it mean to "move along the demand curve"?

The price and quantity demanded is changing.

* What does it mean for a firm to supply a good or service?

The firm has the resources and technology to produce it, can profit from selling
it, and has made a definite plan to produce and sell it.

* What is the lowest price that a firm is willing to selling a product?

At the product's marginal cost.

* What is the law of supply?

Other things remaining the same, the higher the price of a good, the greater
the quantity supplied.

* When are producers willing to supply a good?

If they can at least cover their marginal cost of production.

* What are the 6 factors that change supply?

1. Prices of factors of production
2. Prices of related goods
3. Expected future prices
4. Number of suppliers
5. Technology
6. State of nature

* What is a substitute in production?

A good that can be produced with the same resources.

* What is a complement in production?

Goods that must be produced together.

* What does an increase in supply do to the supply curve?

Shifts it to the right.

* What is the equilibrium price and quantity?

The price at which quantity demanded == quantity supplied, and the
quantity bought and sold at that price.

* What is a shortage?

When quantity demanded > quantity supplied, created when the price is too low.

* What is a surplus?

When quantity demanded < quantity supplied, created when the price is too high.

* What happens to the equilibrium price and quantity when demand increases?

Price rises, quantity rises.

* What happens to the equilibrium price and quantity when demand decreases?

Price lowers, quantity lowers.

* What happens to the equilibrium price and quantity when supply increases?

Price lowers, quantity rises.

* What happens to the equilibrium price and quantity when supply decreases?

Price rises, quantity lowers.

* What happens to the equilibrium price and quantity when both demand and supply increases?

Price is unknown, quantity rises.

* What happens to the equilibrium price and quantity when both demand and supply decreases?

Price is unknown, quantity lowers.

* What happens to the equilibrium price and quantity when demand increases and supply decreases?

Price rises, quantity is unknown.

* What happens to the equilibrium price and quantity when demand decreases and supply increases?

Price lowers, quantity is unknown.

# Elasticity

* What is elasticity?

A unit-independent measurement of the responsiveness of quantity vs price.

* How do we calculate the price elasticity of demand?

Percentage change in quantity demanded / percentage change in price

* How we calculate the percentage changed w.r.t elasticity?

(New - Initial) / ((New + Initial) / 2)

* When does a good have perfectly inelastic demand?

When the price elasticity of demand is 0. (i.e. when the demand curve is
vertical)

* What is the definite of unit elastic demand?

When the price elasticity of demand is 1.
When the % change in quantity demanded equals the % change in price.

* When does a good have inelastic demand?

When the price elasticity of demand is less than 1.

* When does a good have elastic demand?

When the price elasticity of demand is greater than 1.

* When does a good have perfectly elastic demand?

When the price elasticity of demand is infinite.
When the demand curve is horizontal.

* What are the 3 factors that influence the elasticity of demand?

1. Closeness of substitutes
  Closer the substitutes, more elastic
2. Proportion of income spent on the good
  Greater the portion of income, more elastic
3. Time elapsed since a price change
  More time consumers have to adjust to a price change, more elastic
  Unperishable goods are elastic

* How do we calculate the total revenue?

Price of good * quantity sold.

* What should we do if demand is elastic?

Lower the price, because a 1% drop in price means a > 1% increase in sales.

* What should we do if demand is inelastic?

Raise the price, because a 1% raise in price results in a <1% decrease in sales.

* What should we do if demand is unit elastic?

Nothing.

* What is the total revenue test?

A method of estimating the price elasticity of demand

Observe the change in total revenue from a price cut.
  If down, inelastic
  If up, elastic
  If nothing, unit elastic

* At what point do we achieve maximum revenue?

When we produce at the point where the price elasticity of demand is unit elastic.

* How is your expenditure affected by price elasticity of demand?

If your demand is:
  elastic, then 1% price cut means you'll spend more than 1% more on the item.
    Expenditure increases
  inelastic, then 1% price cut means you'll spend less than 1% more on the item
    Expenditure decreases
  unit elastic, then 1% price cut means you'll spend 1% more on the item
    Expenditure does not change

* What is the income elasticity of demand?

Measures how the quantity demanded responses to a change income.

% change in quantity demanded / % change in income.

* When is a good income elastic?

When the income elasticity of demand is greater than 1.

* When is a good income inelastic?

When the income elasticity of demand is less than 1.

* When is a good inferior?

When the income elasticity of demand is less negative.
When income decreases, quantity demanded increases.

* What is the elasticity of supply?

Measures how the quantity supplied changes in response to price changes.

% changed in quantity supplied / % change in price

* When is supply perfectly inelastic?

When the elasticity of supply is 0.
When the supply curve is vertical.

* When is supply perfectly elastic?

When the elasticity of supply is infinite.
When the supply curve is horizontal.

* When is supply unit elastic?

When the supply curve is linear and passes through the origin.
NOTE THAT SLOPE IS IRRELEVANT.

* What are 2 factors that influence the elasticity of supply?

1. Resource substitution possibilities
  Easier to substitute among the resources use to produce good => more elastic
2. Time frame for supply decision
  More time that passes after price change => more elastic

* What is momentary, short-run, and long-run supply and their elasticity?

Momentary: Perfectly inelastic.
Short-run: Somewhat elastic.
Long-run: Most elastic.

* What is cross elasticity of demand?

Comparison of how Product A's quantity demanded changes when Product B's price changes.

% change in quantity demanded of Product A / % change in price of Product B

* When are two goods close substitutes?

When their cross elasticity of demand is high.
(A small increase in price of A causes quantity demanded for B to shoot up.)

* When are two goods substitutes?

When their cross elasticity of demand is positive.
(An increase in price of A causes quantity demanded for B to increase.)

* When are two goods unrelated?

When their cross elasticity of demand is 0.

* When are two goods complements?

When their cross elasticity of demand is negative.
(An increase in price of A causes quantity demanded for B to decrease.)

# Utility

* What are comsumption possibilities?

All the things that you can afford to buy.

* What are consumption possibilities limited by?

The consumer's income and the price of the goods.

* What is a budget line?

A visualization of the limits of her consumption possibilities.
A consumption choice is affordable iff it is on a point below the budget line.

* What is utility?

The benefit or satisfaction from consuming a good or service.

* What is marginal utility?

The change in total utility that results from a unit-increase in the quantity of
the good consumed.

* What is the principle of diminishing marginal utility?

As quantity of the good consumed increases, the marginal utility of each
additional consumption decreases.

* How do we assume we will choose our consumption?

We choose the consumption choice that maximizes total utility.

* What is the consumer equilibrium?

The situation where we have allocated all of our income in the way that
maximizes our total utility.

* What is the marginal utility per dollar?

The marginal utility from a good divided by its price.

* What is utility-maximizing rule?

A consumer's total utility is maximized by:

- Spending all available income; and
- Equalizing the marginal utility per dollar for all goods.

* How do consumption choices move when the price of a good falls?

The consumer will buy more of that good, and buy less of another good, to
restore consumer equilibrium.

* How do consumption choices move when the price of a good rises?

The consumer will buy less of that good, and buy more of another good, to
restore consumer equilibrium.

* How do consumption choices with normal goods move when income rises?

The consumer will buy more of both goods, in proportions that maintain consumer
equilibrium.

* What is the paradox of value?

Why do essential goods, such as water, cost less than luxury goods, such as
diamonds.

* What is the resolution for the paradox of value?

While the total utility gained from essential goods is high, we use so much of
it that the marginal utility is low.

In contrast, the marginal utility of a luxury good is high.

* What does behavioural economics study?

The ways in which limits on humans' abilities to implement rational decisions
influences economic behaviour.

* What are the 3 impediments to rational choice?

1. Bounded rationality
2. Bounded willpower
3. Bounded self-interest

* What is an example of bounded rationality?

When faced with uncertainity, consumers cannot rationally make choices.

* What is the endowment effect?

The tendency for people to value something more highly because they own it.

* What is neuroeconomics?

The study of the activity of the human brain when a person makes an economic
decision.

* What is the controversy with explaining consumer choices?

Should economics focus on explaining the decisions we observe or the thoughts
in people's heads?

# Possible preferences

* How do we calculate real income in terms of a good?

Income / price of good.

* How do we calculate relative price between two goods?

Price of good 1 / Price of good 2

* What happens to the budget line when the price of a good changes?

The budget line rotates.

* What happens to the budget line when income changes?

The budget line translates.

* What is an indifference curve?

A line that shows combinations of goods among which a consumer is indifferent.

* What are the 3 categories of consumption choices in an indifference curve?

1. Below the curve: Not preferred
2. On the curve: Just as good
3. Above the curve: Preferred

* What is a preference map?

A series of indifference curves.

* What is the marginal rate of substitution?

The rate at which a person is willing to give up Good 1 to get an additional
unit of Good 2, while remaining indifferent.

* How do we calculate the marginal rate of substitution?

It is the slope of the indifference curve.

* What is the diminishing marginal rate of substitution?

The general tendency for a person to be less willing to give up some of Good 1
to get one more Good 2, as the quantity of Good 2 increases.

* What does the indifference curve show when the goods are perfect complements?

Straight (vertical/horizontal) line while we have more of one good than the
other. This is because we cannot use more of one without more of another.

* What does the indifference curve show when the goods are perfect substitutes?

A straight, sloped, line.

* What does the indifference curve show when the goods are ordinary goods?

A round curve.

* What are the 3 properties of a consumer's best affordable choice?

1. On the budget line
2. On the highest attainable indifference curve.
3. Has a marginal rate of substitution equal to the relative price of the two
   goods.

* Where is a consumer's best affordable choice on the graph?

The intersection between the budget line and the best indifference line.

* How is can we explain the gain in quantity consumed when price falls with 2 effects?

1. Substitution effect: changes the slope of the budget line while staying at
   the original indifferent curve.
2. Income effect: Shifts the budget line to a new indifference curve.

# Organizing production

* What is a firm?

An institution that hires factors of production and organizes them to sell
goods and services.

* What is a firm's goal?

To maximize profit.

* What happens if a firm fails to maximize profit?

It will be eliminated or taken over by a firm that seeks to maximize profit.

* What is the difference between accounting and economic profit?

Accounting's "total cost" is the total monetary expenses.
Economic's "total cost" is the opportunity cost of production.

* What is a firm's opportunity cost of production?

The value of the best alternative use of the resources a firm uses in
production.

* What are the 3 things that contribute to a firm's opportunity cost of production?

Cost of using resources:

1. Bought in the market
2. Owned by the firm
3. Supplied by firm's owner

* Why are resources bought in the market considered a part of the firm's opportunity cost of production?

The firm could have bought difference resources to provide another good or
service.

* Why are resources owned by the firm considered part of their opportunity cost of production?

The firm could have sold their capital or rented their capital from another firm.

* What is the implicit rental rate of capital?

The opportunity cost of using the capital a firm owns itself.

* What are the two concepts that make up the implicit rental rate of capital?

1. Economic depreciation; change in market value of capital in a given period.
2. Interest forgone; return on the funds used to acquire the capital.

* What is normal profit?

The profit that an entrepreneur can expect to receive on average.
It is the cost of entrepreneurship and an opportunity cost of production.

* What is the opportunity cost of the owner's labour?

The income forgone by not taking the best alternative job.

* What are the 5 basic decisions a firm makes to maximize profit?

1. What and how much to produce?
2. How to produce?
3. How to organize and compensate employees?
4. How to market and price its products?
5. What to produce itself vs buy from other firms?

* What are the 3 constraints that limit a firm's profit?

1. Technology constraints.
2. Information constraints.
3. Market constraints.

* How do technology constraints limit a firm's profit?

Using the available technology, the firm can produce more only if it hires
more resources, which will increase its costs and limit the profit.

* How do information constraints limit a firm's profit?

A firm never possess complete information about the present or future, and the
cost of coping with limited information limits profit.

* How do market constraints limit a firm's profit?

The price of a good is limited by its customer's willingness to pay, and by
the prices and marketing efforts of other firms.

The resources a firm can buy are limited by the prices it must spend on them,
and the willingness for people to work/invest in the firm.

A firm must spend money to overcome these constraints.

* When is technological efficiency achieved?

When a firm uses the least amount inputs to produce a given quantity of output.
Does not care about cost.

* When is economic efficiency achieved?

When a firm produces a given quantity of output at the least cost.

* What is the difference between technological and economic efficiency?

Technological: Concerned with quantity of inputs
Economic: Concerned with cost of inputs

* Why does economic efficiency imply technological efficiency, but not vice versa?

Because if you can reduce some inputs, you can lower the cost. (E => T)
However, you can have many variations on with lowest input, but only a few
have lowest cost. (T =/> E)

* What are the two systems a firm uses to organize production?

1. Command systems.
2. Incentive systems.

* What is a command system?

A managerial hierarchy where commands pass downwards and information passes
upwards. Rigid can have many layers of specialized management.

* What is an incentive system?

A method of organizing production that uses a market-like mechanism to induce
workers to perform in ways that maximize profit.

* Why do firms use command or incentive systems?

Command: Easy to monitor performance; small deviation from ideal performance is
costly.
Incentive: Monitoring performance is too hard.

* What is the principal-agent problem?

The problem of devising compensation rules that induce an agent to act in the
best interests of a principal.

* What are the 3 ways to cope with the principal-agent problem?

1. Ownership; gives managers incentive to maximize profits.
2. Incentive pay; links manager pay to firm's performance.
3. Long-term contracts; tie long-term rewards to long-term performance of firm.

* What are the 3 times of business organization?

1. Sole proprietorship
2. Partnership
3. Corporation

* What is a sole proprietorship?

A firm with a single owner.
Owner has unlimited liability.
Owner makes management decisions and receives profit.
Profits are taxed like owner's other income.

* What is a partnership?

A firm with multiple owners.
Multiple owners have unlimited liability.
Partners must agree on management structure and profit division.
Profits are taxed as personal income of owners.

* What is a corporation?

A firm owned by stockholders.
Liability is limited up to initial value of investment.
Profits are taxed twice: corporate tax then income tax.

* What are the advantages and disadvantages of sole proprietorships?

+ Easy to set up
+ Managerial decision making is simple.
+ Profits only taxed once

- Bad decisions not subject to review
- Entire owner's wealth is at risk
- Firm dies with owner
- Cost of capital and labour can be high

* What are the advantages and disadvantages of partnerships?

+ Easy to set up
+ Employ diversified decision-making processes
+ Can survive withdrawal of a partner
+ Profits only taxed once

- Achieve consensus with managerial decisions is difficult
- Entire owners' wealth at risk
- Capital is expensive

* What are the advantages and disadvantages of corporations?

+ Limited liability
+ Large-scale and low-cost capital
+ Professional management
+ Lower costs with long-term labour contracts

- Complex (slow and expensive) management structure
- Profits taxed twice

* What are the 4 market types?

1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Monopoly

* What are the properties of a perfect competition market structure?

- Many firms and many buyers
- All firms sell identical product
- No barriers to entry
- Firms and buyers are all well informed about all prices and products.

* What are some examples of perfect competition?

Wheat, corn, and other grains.

* What are the properties of a monopolistic competition market structure?

- Many firms
- Each firm produces a slightly different product.
- Each firm possesses an element of market power.
- No barriers to entry.

* What is product differentiation?

The difference between firms' products of the same good.

* What are the properties of an oligopoly?

- Small number of firms
- Firms produce almost identical or differentiated products.
- Significant barriers to entry

* What are the properties of a monopoly?

- One firm produces entire output
- No close substitutes for product
- Heavy barriers to entry

* How do economists determine the market structure of an industry?

By measuring the extend to which a small number of firms dominate the market.

* What are the 2 ways economists measure market concentration?

1. Four-firm concentration ratio
2. Herfindahl-Hirschman index (HHI)

* What is the four-firm concentration ratio?

The percentage of the total industry sales account for by the four largest
firms in the industry.

* What is the Herfindahl-Hirschman index?

The square of the percentage market share of each firm summed over the largest
50 firms in the industry.

* What are the 3 limitations of using concentration measures to determine market structure?

1. Geographical scope of the market
2. Barriers to entry and firm turnover
3. Correspondence between a market and an industry

* What is firm coordination?

Firms hire labour, capital, and land, and use command/incentive systems to
produce goods and services.

* What is market coordination?

Markets adjust prices and make the buyers and sellers of factors of production
have consistent decisions.

* What is outsourcing?

Buying parts of products from other firms.

* When do firms coordinate production?

When they can do so more efficient than the market.

* Why are firms more efficient at coordination than markets?

1. Lower transaction costs
2. Economies of scale
3. Economies of scope
4. Economies of team production

* What are transaction costs?

Costs arising from finding someone to do business, agreeing on the exchange, and
ensuring that the terms are fulfilled.

* When do economics of scale occur?

When producing a unit of a good falls as its output rate increases.

* When do economics of scope arise?

When a firm can use specialized inputs to product a range of different goods
than otherwise possible.

* What is the concept of economies of team production?

Individuals can specialize in mutually supporting tasks.

# Output and Costs

* What are the two time frames a decision can be placed into?

1. The short run
2. The long run

* What is the short run time frame?

The time frame in which the quantity of one or more resources used in production
is fixed.

Short-run decisions can be easily reversed.

* What is the long run time frame?

The time frame in which the quantities of all resources can be varied.

* What is a sunk cost?

A cost incurred by the firm and cannot be changed.

* How can a firm increase output in the short run?

A firm must increase the labour employed.

* What is the total product?

The total output produced in a given period.

* What is the marginal product of labour?

The change in total product that results for a one-unit increase in the
quantity of labour employed, all other inputs remaining the same.

* What is the average product of labour?

The total product divided by quantity of labour employed.

* What happens as quantity of labour employed increases?

- Total product increases;
- marginal product increases, but eventually decreases;
- Average product decreases.

* What is a product curve?

- Something that shows how the firm's total product, marginal product, and
average product change as the firm varies the quantity of labour employed.

* What is the total product curve?

Similar to the PPF, separates attainable from unattainable output levels in the
short run.

* What is the law of diminishing returns?

As a firm uses more of a variable input with a given quantity of fixed inputs,
the marginal product of the variable input eventually diminishes.

* What is the relationship between average product and marginal product?

When marginal product exceeds average product, average product increases.

* What is the point of maximum average product?

Where the average product curve intersects with the marginal product curve.

* What is the only way companies can produce more output in the short-run?

Employing more labour.

* What is total cost?

The cost of all resources used.

* What is total fixed cost?

The cost of the firm's fixed inputs. Fixed costs do not change with output.

* What is total variable cost?

The cost of the firm's variable inputs. Variable costs do change with output.

* Where does the total variable cost curve get its shape?

From the total product curve. It's the same curve, just transposed.

* What is marginal cost?

The increase in total cost that results from a one-unit increase in total
product.

* What is the shape of the average fixed cost curve?

A curve that slowly decreases over time.

* What is the shape of the average variable cost curve?

A u-shape, because AVC falls and then increases.

* What is the shape of the average total cost curve?

A u-shape, because AVC will dominate.

* What is the point of minimum variable cost?

Where the marginal cost intersects with the average variable cost curve.

* What is the point of minimum total cost?

Where the marginal cost intersects with the average variable cost curve.

* Why is the average total cost curve u-shaped?

1. Total fixed cost is spread over a larger output.
2. Law of diminishing returns eventually dominates.

* What is the relationship between marginal product and marginal cost?

When MC is at it's minimum, MP is at its maximum.

* What is the relationship between average variable cost and average product?

Min(AVC) = Max(AP)

* What are the 2 factors that shift the positions of a firm's average cost curves?

1. Technology; better technology decreases cost and increases product. (shifts up and down)
2. Prices of factors of production; shifts only costs.

* What is the production function?

The relationship between the maximum output attainable and the quantities of
both capital and labour.

* What is the marginal product of capital?

The increase in output resulting from a one-unit increase in the amount of
capital employed, holding constant the amount of labour employed.

* What is the long run average cost curve made up of?

The lowest ATC for each output level.

* What are economics of scale?

Features that lead to falling long-run average cost as output increases.

* What are diseconomics of scale?

Features that lead to rising long-run average cost as output increases.

* What are constant returns to scale?

Features that lead to constant long-run average cost and output increases.

* What is the minimum efficient scale?

The smallest quantity of output at which the long-run average cost reaches its
lowest level.

# Perfect competition

* What is perfect competition?

A market in which:
- Many firms sell identical products to many buyers
- There are no restrictions to entry into the industry
- Established firms have no advantages over new ones
- Sellers and buyers are well informed about prices

* When does perfect competition arise?

- When the firm's minimum efficient scale is small, relative to market demand.
- When each firm is perceived to produce a good that has no unique characteristics.

* What is a price taker?

A price taker is a firm that cannot influence the price of a good.

* In perfect competition, what is the demand for each firm's product?

Perfectly elastic, as each firm's output is a perfect substitute.

* What is total revenue?

Price x quantity sold.

* What is marginal revenue?

The change in total revenue that results from a one-unit increase in quantity sold.

* In perfect competition, what are the 3 decisions a firm must make?

1. How to produce at minimum cost?
2. What quantity to produce?
3. Whether to enter or exit a market?

* In perfect competition, what is a firm's output decision?

To produce at the point that maximizes economic profit. The point at which
marginal revenue equals marginal cost.

* How does a firm decide whether or not to shutdown?

It wants to incur the lowest possible loss. If the firm cannot produce at a
point where its loss is less than the TFC, it will shutdown.

* What is a firm's shutdown point?

The price and quantity at which it is indifferent between producing the
profit-maximizing quantity, and shutting down.

It is at the minimum AVC.

* What does a firm produce at a price below it's shutdown point?

Nothing.

* What does the short-run market supply curve show?

The quantity supplied by all firms in the market at each price when each
firm's plant and the number of firms remain the same.

* How do we check if a firm is making a profit?

We compare the firm's ATC at the profit maximizing output with the market price.

* In perfect competition, what happens to a firm's profit in the long-run?

They break-even, because firms can enter or exit the market.

* What is consumer surplus?

The area below the demand curve up to the equilibrium point.

* What is producer surplus?

The area above the supply curve up to the equilibrium point.

# Monopolies

* What is a monopoly?

A market that produces a good with no close substitute.
There is one supplier with high barriers to entry.

* What are the 3 barriers to entry?

Natural: Economics of scale.
Ownership: Key resource is owned by one place.
Legal: Laws. (e.g. Public Franchise)

* What is a single-price monopoly?

A firm that must sell each unit of output for the same price.

* What is price discrimination?

The practice of selling different units of goods at different prices.

* How MR tell you at which point demand turns inelastic?

When MR is negative.

* In monopoly, why is demand always elastic?

Monopolies will never produce at an output which demand is inelastic, since
MR is negative.

* How is economic profit calculated?

Total revenue - Total costs.

OR

Producer surplus - Total fixed cost.

* What is deadweight loss?

The loss in consumer and producer surplus due to monopoly behaviour.

* What is economic rent?

Any consumer/producer surplus and economic profit.

* What is rent seeking behaviour?

The pursuit of wealth by capturing economic rent.
Buy a monopoly or create a monopoly.

* When can a monopoly price discriminate?

When they can:
1. Identify and separate different buyer types.
2. Sell a product that cannot be resold.

* What are the two ways to price discriminate?

1. Among groups of buyers.
2. Among units of a good.

* When does perfect price discrimination occur?

When a firm is able to sell each unit for the highest price someone is willing
to pay.

* What are regulations?

Rules by the government to influence economic activity.

* What is social interest theory?

The processes that regulates to eliminate deadweight loss.

* What is capture theory?

The regulation that serves the self-interest of the producer.

* What is the marginal cost pricing rule?

A regulation that makes the monopoly set the price equal to marginal cost.

* What is the average cost pricing rule?

A regulation that makes the monopoly set the price equal to average cost.

* Why is it hard to implement average cost pricing?

Because regulators don't always know firm's costs.

* What is rate of return regulation?

A firm must justify its price by showing that its return on capital does not
exceed a limit.

* What is a price cap regulation?

A price ceiling.

# Monopolistic competition

* What is monopolistic competition?

A market structure where:
- Many firms compete
- Each firm has a differentiated product.
- Compete on quality, price and marketing
- Free to enter and exit industry.

* What do the large number of firms in monopolistic competition imply?

- Each firm as a small market share.
- Each firm is sensitive to average market price, but pays no attention to
other firms' actions.
- Collusion is impossible.

* What is product differentiation?

Making a slightly different product than other firms.

* What are the two main forms of marketing?

Advertising and packaging.

* What are the two key differences between perfect and monopolistic competition?

Excess capacity: Produces less than the minimum ATC.
Markup: Price exceeds marginal cost.

* How does advertising affect ATC?

ATC shifts upwards, but increased demand means you can produce at a lower
place.

* What is a signal?

An action taken by an informed person to send a message to uninformed people.

# Oligopoly

* What is an oligopoly?

A market structure where:
- Natural or legal barriers to entry exit
- Small number of firms compete.

* What are the consequence of having a small number of firms in an oligopoly?

Interdependence: Firm's profit depends on every firm's actions
Temptation to Cooperate: Form a cartel.

* What is game theory?

A tool to study strategic behaviour.

* What are the four components of a game?

Rules: The setting of the game.
Strategies: All possible actions of each player.
Payoff: Consequence of each action.
Outcome: The result of game.

* What is the Nash equilibrium?

The equilibrium action assume all players are rational.

* What is a collusive agreement?

An agreement to restrict output, raise prices, and increase profits.

* What is a cooperative equilibrium?

A situation where firms share the monopoly profit.

* What is a tit-for-tat strategy?

Cooperates/cheats each round depending on the action of opponent last round.

* What is a trigger strategy?

Cheats every round if opponent cheats once.

* What is a contestable market?

A market where firms can enter and leave very easily.

* What is price limiting?

Setting the price at the highest level that can keep the potential entrant out.

# Government actions

* What is search activity?

The time spent looking for someone to do business with.

* What is a black market?

An illegal market that operates without the legal market's regulations.

* What is tax incidence?

The division of the burden of tax between buyers and sellers.

* What is the effect of taxes?

Shifts the supply curve.

# Global markets

* What are imports and exports?

Imports: Goods we buy from other countries
Exports: Goods we sell to other countries.

* What is the fundamental force that generates trade?

(National) Comparative advantage.

* What is the benefit of trade?

Buyers get imported goods cheaper.
Sells can sell their goods international for more money.

* What is a tariff?

Tax on an imported good.

* What is dumping?

A foreign firm sells its exports at a lower price than its cost of production.

* Why are there trade restrictions?

Because companies are angry that their producer surplus is lower.