Define a monopoly.

A monopoly is when one firm has significant control over the quantity produced of a specific output. Monopoly is not determined by the size of a company, but by its ability to control production. Other aspects of monopoly are the inability of other producers to enter the market place for the good or service; a lack of competition for a good or service; and a lack of substitute goods.

Define the concept of profit maximization. What does a firm try to set to maximize profit? Why?

Profit maximization is the simple concept that firms what to maximize their profit – to make as much money as possible.  For an individual firm the demand curve is a horizontal like across all quantities set at the market price for the output:

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In the above chart, the demand curve for an individual firm is represented by the dotted line (d). Regardless of what quantity a firm produces, the maximum price they can sell their output for is price p (market price). If the firms output is anything below quantity q (assuming marginal cost (MC) is below marginal revenue (MR)), they will not be maximizing their profit as they could sell more product at the same price.  Similarly, if a firm is producing more output than quantity q, their MC would be greater than their MR and they again would not be maximizing profits. A firm can continue to produce more product to the point where MC = MR.

An individual firm has no control over price. They do have some control over marginal cost, but assuming the firm is running as efficient as possible, this is not a variable that they can control in this example. Therefore, the main variable a firm can control to maximize profit is output.               

In the earlier chapters the supply and demand models you learned about defined supply as the combined actions of all suppliers. In this chapter the behavior of individual firms is studied. An individual firm faces a marginal cost curve (MC). Define the marginal cost curve. Why does it tilt from lower left to upper right? 

The Marginal cost curve shows the marginal cost for an individual firm. That is, the cost to the firm for producing a single unit output. Marginal cost will typically slope from lower left to upper right as the cost is a representation of the production function of the firm. That is, as the firm continues to produce more output, they will be slightly less efficient and therefore the marginal cost will increase. 

An individual firm is a price taker. It has no power to set price because it is just one small supplier in the market. This is shown by the individual firm’s marginal revenue curve (MR). Describe the attributes of the MR and where it comes from.

Marginal revenue is a firm’s increase in revenue from selling one additional unit of output. Because a firm has no power to set price, the MR curve is a straight line set at the market price for its product. 

Define marginal revenue (MR). Note: It may help you to relate total revenue to MR.

Marginal revenue is a firm’s increase in revenue from selling one additional unit of output. Because a firm has no power to set price, the MR is the market price for its product at all quantities. Total revenue is the output times the marginal revenue. For example:

Output         Marginal Revenue           Total Revenue

1                              $10                         $10

2                              $10                         $20

3                              $10                         $30

Marginal revenue in all cases is the market price for the product, in this example, $10.00. 

Define profit.

Profit is the total revenue minus total cost. 

Economists usually use two dimensional graphical representations to view economic issues. In this chapter tables are also used to relate output, revenue, and profit. Describe the concept of MC as show in the table.

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Define the concept of barriers to entry

Barriers to entry are obstacles in the path of a firm that make it difficult to enter a given market. Barriers to entry are the source of a firm's pricing power - the ability of a firm to raise prices without losing all its customers. The term refers to hindrances that an individual may face while trying to gain entrance into a profession or trade. It also, more commonly, refers to hindrances that a firm (or even a country) may face while trying to enter a market, industry or trade grouping. Barriers to entry restrict competition in a market.

Contrast the protectionist viewpoint with the free trade viewpoint.

·         Protectionists

o   Want to reduce foreign competition against U.S. goods and services.

o   Import restrictions are necessary to remedy balance of trade and balance of payments problem.

o   Certain key industries in the US are vital to our security and to our economic welfare.

o   Trade barriers are necessary to protect Earth’s natural environment and to prevent the exploitation of the world’s impoverished workers.

·         Free Trade

o   The interests of consumers worldwide are best served if economic units in all countries are free to engage in whatever voluntary exchanges they believe will be advantageous to them.

Earlier you studied production possibilities curves (PPC). In this chapter the concept of a consumption possibilities curve (CPC) is introduced. Define CPC.

Similar to the PPC, the CPC is a graph of the maximum quantity of goods or service consumers in an economy can consume when resources efficiencies are maximized. Without trade the CPC is the same as the PPC because consumers cannot consume more than is produced.

How can a society consume more than it produces using trade?

If a society has a comparative advantage and specializes in the production of this good, they can then trade for goods in which they have a comparative disadvantage. The result will be that that CPC will push out (or rotate) from the PPC and the society can consume more that it produces.

How is the fact that a society can consume more that it produces show graphically using PPC and CPC?

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If a societies PPC looks like the above solid line, this would mean the society, using all of its resources efficiently, could produce 200 lbs of corn or 100 lbs of sugar or any combination on the PPC.  The society might choose to produce 100 lbs of corn and 50 lbs of sugar (as represented by the dotted line). However, if that society could trade 100 lbs of corn for 100 lbs of sugar, they could put all of their resources in corn production (200 lbs), and trade 100 lbs. The PPC would remain unchanged; however, their CCP would push out (or rotate) from the PPC as indicated by the dashed line.

If a society did not trade then its’ CPC overlaps with its’ PPC. What does this indicate about the well being of society as trade is introduced?

If a society does not engage in trade and its’ CPC and PPC overlap, this means the society can consume no more than it can produce. With trade, it becomes possible to consume more than is produced domestically. Trade enables the totality of consumers in each country to achieve higher satisfaction levels. 

Define comparative advantage. How does this relate to trade?

Comparative advantage is the ability of a country to produce a good or service at a lower opportunity cost than another country. If a country has a comparative advantage in the production of a good or service, they should focus production on this output and trade for an output for which they have a comparative disadvantage. 

Define exchange rates

Exchange rates are the price of one countries money in terms of the monetary units of another country.

A tariff is a tax used to limit trade. If an import tariff is put in place in competitive market what impact does this have on the market supply curve? What will be the impact on price and quantity?

If a tariff is placed on an import the supply curve will shift up, or to the left because the marginal cost of producing the good has increased. With this shift in the supply curve, demand for the imported good will decrease. As demand for the imported good decreases, demand for a domestic substitute good will increase. As the demand for the domestic good increases, the price will rise. Therefore, the effect of a tariff is a lower quantity of the import good being sold at a higher price and a greater quantity of a substitute domestic good being sold at a higher price. 

A quota is a limit by law in the quantity of a good that can be imported during a period of time. If a quota is introduced how is this reflected in the slope (tilt) of the supply curve? What will be the impact on price and quantity?

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When a quota is introduced, this causes the supply curve to become vertical at the quantity of the quota. This causes a new equilibrium at point at a higher price/lower quantity for the good. But the effect on price is actually more dramatic. The above supply-demand curve illustrates this point. Say there is a product that, under a free, unrestricted market would reach an equilibrium point where 150 units would sell at 100 dollars. If a quota of 100 units was imposed, this would cause a vertical supply (s’) at the quota limit. Equilibrium would then slide up the demand curve to a point where 100 units were sold at a price of 150 dollars. But note, under a free, unrestricted market, the suppliers would have been willing to supply 100 units at 50 dollars. So the real price difference is 100 dollars.

Define a voluntary restraint agreement.

A voluntary restraint agreement is a treaty where one country volunteers to restrict its imports of a product it sells to another country.

Define Embargo

An embargo is basically a quota of zero. This is when one country restricts all imports of another country.

What is dumping?

Dumping is the act of charging a lower price for a good in a foreign market than one charges for the same good in a domestic market. Most dumping occurs during recessions when international producers find themselves with surpluses that cannot be sold at home. 

What is a free trade area? What does NAFTA stand for? What countries are members? Do you support it? Why or why not?

A free trade area is an alliance of nations without trade barriers between its members. NAFTA is a Free Trade Area between the US, Canada, and Mexico. Members of a free trade area are allowed to set independent tariffs with nations outside of the alliance. Thus, a free trade area agreement does not require the same degree of cooperation as a customs union.  I support NAFTA because of the principle of comparative advantage: All trading partners gain when they specialize. While it’s true that some jobs will be lost due to NAFTA, others will be created and in the long run, more jobs will be created because of NAFTA than lost. 

Define aggregate demand. Compare aggregate demand to demand as we have referred to it in earlier chapters. What do the letters C, I, and G represent when defining aggregate demand? How do imports and exports affect aggregate demand?

Aggregate demand (AD) is the total demand for goods and services in an economy at all possible price levels. Essentially it is the demand for the Gross Domestic Product of a country. AD = C + I + G + (X-M) where C = Consumer Spending; I = Investment Spending; G = Government Purchases; X = Exports; and M = Imports. Exports increase output demanded, imports reduce output demanded.

Define Aggregate supply. Which producers are included in aggregate supply?

Aggregate supply is a schedule showing the quantity of output supplied in the economy at different price levels. The text doesn’t talk about which producers are included in aggregate supply!

What happens to the aggregate supply curve as the economy nears full employment? Why?

As the economy nears full employment the aggregate supply curve becomes vertical. This is because the economy has maximized it’s labor resources and no significant increase in supply is possible.

What happens to the price level if aggregate demand continues to increase when output (Q) is already at the level sustained by full employment? Can you draw that?

In short, if demand continues to increase when output is already at the level sustained by full employment, prices will increase but there will only be a small amount of economic growth.  In other words, it will amount to inflation:

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The graph above is not a very good looking graph but it explains the concept. Give price (i.e. inflation) on the y-axis and quantity (i.e. Real GDP) on the x-axis and the aggregate supply curve (AS), you can see that for demand D1, equilibrium is reached at quantity Q1. As the demand increases to D2 price increases only a little to P2 however quantity increases significantly to Q2. At this point demand increased when the economy was not near full employment so the economy got significant increase in output for a marginal increase in price. However, when demand continues to increase to D3, near full employment, you can see where the output of the economy (the difference between Q3 and Q2) is smaller while the price (difference between P3 and P2) is much greater. You can imagine with another demand increase there would be even a smaller increase in output but a significant increase in price. Hence, when demand continues to rise as we near full employment, we have inflation.

If the money supply is increased this will cause an increase in aggregate demand. Thus, the government will usually increase the money supply in times when the economy is weak. This is what happened in 2008 and 2009. With other factors held constant what will be the impact of increasing the money supply during a recession?

What is inflation? How does it impact purchasing power?

Inflation is a rise in price. It drives down purchasing power since, in general, goods and services cost more to purchase.

What are the three functions of money? Define each.

1.       A medium of exchange

a.       Goods and services are paid for with money. Without money, economic transactions would transpire on a barter basis.

b.      Simplifies and facilitates the exchange process

2.       A measure of value

a.       Money makes value comparisons of goods and services possible.

b.      It’s not possible to add apples and oranges but it is possible to add the values of apples and oranges.

3.       Store of value

Wealth and assets can be held in the form of money

Economists define money in three ways: M1, M2, and M3. What is the difference in the three? Which is the most inclusive? Least inclusive?

 1.       M1 – This is the least inclusive definition of money. It includes currency and coins in circulation, nonbank traveler’s checks, demand deposits (checking accounts), and other checkable accounts such as NOW (negotiable orders of withdrawal) and ATS(Automatic Transfers of Savings) accounts

2.       M2 – M2 includes M1 plus savings and time deposits of small amounts (less than 100,000) and money market mutual funds.

3.    

M       M3 – This is the most inclusive definition of money. It includes M2 plus time deposits of 100,000 and over.

What is the purpose of the Federal Reserve System (Fed)? How many regional federal reserve banks exist?

There are 12 Federal Reserve Banks. The regional bands act as a central band for private banks in its region. The Fed provides private banks with services such as clearing checks, holding bank reserves or deposits, providing currency, and extending loans.

Open market operations

The purchases and sales of government securities by the Federal Reserve Open Market Committee in order to control the growth in the money supply.

Required Reserve Ratio

The ratio of reserves that banks are required to maintain to demand deposits. 

Discount Rate

The rate of interest that the Federal Reserve Banks charge when banks borrow for the Fed.

The Quantity Theory of Money

 ·         MV = PQ

o   M = money supply

o   V = the velocity of money, how many times in a year a dollar is spent

o   P = the overall price level in the economy

o   Q = the total value in dollars of output of goods.

Define demand-pull inflation. What is the cause of this type of inflation? Can you draw this?

Demand-pull inflation is rightward shifts in the aggregate demand curve and caused by an increase in total spending in the economy. A demand-pull inflation is associated with increases in production and employment in the short run until the economy reaches full employment. Once full employment is reached, further increases in demand increase prices only.

Define cost-push inflation. What is the cause of this type of inflation? Can you draw this?

Increases in costs of producing goods and services cause’s leftward shifts in the aggregate supply curve.  Cost-push inflation is often characterized by inflation and recession at the same time. 

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The above graph shows short run cost-push inflation. The initial aggregate supply is show as curve S and demand is D. When there is an increase to the cost of production the supply curve shifts to the left to S’ which necessitates a rise in price. Demand slides up the demand curve to q1 with a price of p1. Therefore, we have a decrease in output, a decrease in quantity demanded, but a rise in price. 

Define price elasticity of demand. If demand for a good is highly price elastic would the demand curve be steep of flat? What does this mean for the quantity demand as price increases?

Price elasticity of demand is the responsiveness of the quantity demanded of a product to changes in the products price.  If the demand for a good is highly price elastic the demand curve for the produce would be flat. This means that as price increases the effect on demand more dramatic than a product with a steep sloped demand curve.

Is the demand for gasoline elastic or inelastic in the short run? Why?

Inelastic

Do you agree or disagree with the following statement? Why?: Supply can be defined as elastic or inelastic also. An elastic supply curve will be relatively flat when drawn. Thus, a change in price will lead to large changes in the quantity supplied. An inelastic supply curve will be relatively steep when drawn. Thus, a change in price will lead to small changes in the quantity supplied. Elasticity of supply would be defined as measuring the responsiveness of the quantity supplied of a product to change in price.

Agree. Because it’s true.