Term
| Implicit or Opportunity Costs: |
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Definition
| The value of what one is given up |
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Term
| Explicit (Accounting)(Outlay): |
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Definition
| The actual monetary expenditures of a firm |
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Term
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Definition
| Explicit costs of production |
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Term
| Economic Costs- Explicit Costs + Implicit Costs |
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Definition
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Term
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Definition
• Fixed interest payments
• Insurance payments
• Rent/mortgage payments
• Top management salaries
• Fixed depreciation expenses on capital equipment |
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Term
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Definition
| Output increases so does variable costs, decrease in output there is a decrease in variable costs |
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Term
| Examples of Variable Costs |
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Definition
• Hourly labor costs
• Raw materials costs
• Fuel/power/utilities costs
• Transportation or delivery costs |
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Term
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Definition
| a. As the quantity produced increases, the extra (or marginal) cost of producing an additional unit of output eventually increases. |
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Term
| The Law of Increasing Costs is reflected in |
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Definition
| the (eventual) increases in not only MC, but also TC, VC, ATC, and AVC. |
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Term
| Law of Increasing Costs does not effect |
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Definition
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Term
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Definition
| Same as quantity of output |
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Term
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Definition
| Total output per unit of input |
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Term
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Definition
| The additional output produced when the firm employs an additional unit of input. |
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Term
| Law of Diminishing Returns- |
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Definition
| As more of a variable input is added to a fixed input, eventually the additional output will begin to decline. |
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Term
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Definition
| At least one economic input is fixed and cannot be changed in the economic short-run. |
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Term
| Economic Short- Run characteristics |
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Definition
• Firms incur both fixed and variable costs.
• The # of firms in the industry is fixed --- firms cannot enter or leave the industry.
• Firms cannot alter the size of their physical facility.
• Firms cannot alter the # of resources employed ---firms can alter their output levels only by using existing resources more/less intensively.
• Economists do not associate any fixed amount of time with either short or long run |
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Term
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Definition
| All aspects of production (i.e. resources, costs) can change in the economic long-run. |
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Term
| Economic Long-Run characteristics |
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Definition
• All costs are variable in the long-run.
• The # of firms in the industry can change --- firms can enter or leave the industry.
• Firms can alter the size of their physical facility.
• Firms can alter the # of resources employed.
Can layoff or higher number of workers |
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Term
| To maxizmize profits firms must |
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Definition
- Firms must evaluate their “mix” of resources used.
- Firms should produce that output level (Q) that minimizes their per unit production costs (ATC).
- Operate at the minimum point on their ATC curve.
- The economic short-run and economic long-run is not time specific and can be any amount of time. |
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Term
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Definition
- As the firm’s output level increases, the per unit cost of producing the product decreases.
- ↑ Q → ↓ ATC |
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Term
| Causes of Economies of Scale: |
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Definition
- Assembly line production processes
- Specialization of resources
- Efficient use of capital and by-products
- Industry Examples:
- Autos, soft drinks, breakfast cereals, cigarettes, construction, et al. |
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Term
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Definition
• As the firm’s output level increases, the per unit cost of producing the product increases.
↑ Q → ↑ ATC |
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Term
| • Causes of Diseconomies of Scale: |
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Definition
Scarcity of inputs sets in
Managerial and coordination problems with large scale production
• Industry Examples:
Industries that need highly skilled/talented labor, unionization of work force, increasing costs of raw materials. |
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Term
| Constant Returns to Scale |
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Definition
• As the firm’s output level increases, the per unit cost of producing the product remains unchanged.
↑ Q → Constant ATC |
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Term
| • Causes of Constant Returns to Scale: |
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Definition
Scarcity of inputs does not occur.
There is an ample supply of inputs.
• Industry Examples:
Industries that use an unspecialized or relatively unskilled labor force (migrant farming, fast food restaurants, garment assemblers). |
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Term
| Minimum Efficient Scale (MES): |
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Definition
The lowest output level at which a firm can minimize their per unit production costs.
The level of output when ATC is minimized.
The output level at which Constant Returns to Scale begins to set in. |
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Term
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Definition
| Total Product (T(P)P): Quantity of Output |
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Term
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Definition
| (AP) Total Output per unit of input AP=TP/Qinput or AP=DeltaQoutput/Qinput |
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Term
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Definition
| (M(P)P): The additoinal output produced when the firm employs an additional unit of input. MP=DeltaTP/DeltaQinput or MP=DeltaQoutput/DeltaQinput |
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Term
| Law of Diminishing Returns |
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Definition
| As more of a variable input is added to a fixed input, eventually the additional output will begin to decline. |
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Term
| Where does diminishing returns set in? |
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Definition
| Numerically D.R. sets in beyound the max MP value. Graphically beyound the peak of MP curve |
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Term
| Market Models: Pure Competition |
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Definition
Large # of small firms, hundreds of thousands of small firms in the industry; individual buyers/sellers cannot affect market price/output levels. Homogeneous standardized Identical-every firm produces the same product
No none-price competition-Advertising
No Barriers to Entry/Exit; very easy to leave the industry
Every firm charges identical price-Pricetakers- the individual firms must take the price that was determined by the industry as a whole.
*Industry has a downsloping demand curve and an upsloping supply curve*
*Firm has a prefectly elastic demand curve*
Profit, Loss, Breakeven in the short-run
Breakeven(normal profit)- Purely competitive firms will earn only a normal profit in the economic long-run
Example of Pure Competition-Agriculture |
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Term
| Short-Run Profit-Maximizing and Loss-Minimizing |
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Definition
-Determine"Q"(where MR=MC-Quantity Axis)
-Determine "P"(where MR=MC,AR-Price axis)
-Determine "TR"(TR=PricexQuantity)
-Determine "TC'(where MR=MC-ATC-Price axis TC=ATCxQ)
-Determine "NR" (NR=TR-TC) |
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Term
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Definition
Increasing, Decreasing, and Constant Costs Industries
↑ Demand → ↑ Supply
↑ Demand > ↑ Supply
Shortages of inputs → ↑ Costs
↑ Production Costs → ↑ Prices
Draw a line that goes through the two equilibrium points. This is the Long-Run Supply Curve.
Industries employing highly skilled labor and/or encounter input scarcities and diseconomies of scale are Increasing Costs Industries. |
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Term
Increasing, Decreasing, and Constant Costs Industries
Decreasing Costs Industries |
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Definition
↑ Demand → ↑ Supply
↑ Demand < ↑ Supply
Surpluses of inputs → ↓ Costs ↓ Production Costs → ↓ Prices
Draw a line that goes through the two equilibrium points. This is the Long-Run Supply Curve.
Industries that do not encounter input scarcities and experience economies of scale are Decreasing Costs Industries. |
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Term
Increasing, Decreasing, and Constant Costs Industries
Constant Costs Industries |
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Definition
↑ Demand → ↑ Supply
↑ Demand = ↑ Supply
No surpluses/shortages of inputs → Constant Costs and Constant Prices
Draw a line that goes through the two equilibrium points. This is the Long-Run Supply Curve.
Industries that have an ample supply of inputs and experience constant returns to scale are Constant Costs Industries. |
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Term
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Definition
1. Large, # of small firms
2. Product differences (Real or Imagined)
3. Non-Price Competition-Advertising Substantial (Lower cost advertising)
4. Barriers to Entry/Exit- Easy to enter/leave
5. Price differences—but similar
6. Profit, Loss, Breakeven
7. Breakeven (normal π) |
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Term
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Definition
1. Only a few firms
2. Homogeneous or Differentiated
3. Substantial (Higher cost advertising)
4. Barriers exist
5. Similar, but different prices |
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Term
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Definition
- One large firm (Firm= Industry)
o Dominates the industry
o The firm can affect the market price and output
o Example: Large utility companies
- Unique product is produced
o The firm produces a product that no other firm is producing.
- Firm is a price-maker
o A monopoly has some control over a product’s price
o The price is not necessarily the highest price the monopolist can get for the product.
o The monopolist will charge a price that will maximize the firm’s revenues and profits.
o Even a monopolist must be concerned with elasticity.
o Even a monopolist must be concerned with elasticity.
To attract more buyers (Increase in QD), the monopolist must decrease price.
- Firm may use good-will advertising
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- Barriers to entry into the industry exists
o One firm continues to dominate the industry because barriers prevent other firms from entering the industry. |
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Term
| Barriers to entry include: |
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Definition
• Economies of Scale and Natural Monopolies
o A “natural monopoly” is a monopoly that has huge fixed costs and relatively low variable costs to begin production.
o Firms must earn enough revenue to cover all of their production costs
To break-even: AR=ATC
ATC=AFC+AVC
Total Variable Costs and therefore AVC are already low |
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Term
| Barrier: Ownership or Control of Essential Resources |
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Definition
A firm that monopolizes the production of a final product may also own the source(s) of the inputs needed to produce that product.
• Example: The world’s largest diamond producer, DeBeers, own most of the diamond mines in South Africa |
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Term
| Legal Barriers: Patents/Copyrights & Licenses |
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Definition
Patents: People one firm the sole right to produce a product for 20 years
• Example: Pharmaceutical companies
Copyrights: Provide the creator or producer of a product the sole right to its production and distribution.
Licenses: Licensing requirements may limit the # of producers/providers of a product
• Example: Liquor License |
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Term
| Limit Pricing and Other Strategic Barriers |
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Definition
An existing firm may make it difficult for a new firm to earn a profit by using a ”limit pricing” strategy.
• The existing firm may cut the selling price of their product so low, and even operate at a loss for a short while, in an effort to force a new firm out-of-business.
• Difficult to prove that the intent was to force the new firm out of business |
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Term
| Pure Monopoly short-run/pricing |
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Definition
A monopoly is a “price maker” and has some control over the price charged.
-Short-Run pure monopoly can obtain profit, a breakeven situation, and possibly a loss.
-In the Long Run there is NO even where there is a loss |
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Term
| Pure Monopoly Sub-type: Regulated Monopoly |
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Definition
-Comparing price and output levels of a regulated monopoly with those of a pure monopoly and pure competition.
oRegulated Monopoly: Price and output are both determined where AR=ATC
oPure Monopoly: Output is determined where MR=MC Price is determined where MR= MC AR.
oPure Competition: Price and output are both determined where AR=MC |
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Term
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Definition
- Price discrimination occurs when the seller:
o Charges different prices
o For the same good or service
o In the same or different markets
Examples: Different prices can be determined by characteristic(s) of the buyer(s) (i.e. age, member of an organized group), date/time of purchase of product, quantity purchased. |
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Term
| Main reason sellers use price discrimination: |
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Definition
oTo increase QD by attracting buyers who are unable/unwilling to pay higher prices
oThis will increase seller’s revenues and profits
-For price discrimination to be successful:
oSeller must be able to segment the market into multiple demand elasticity’s
Buyer whose demand is more inelastic is charged a higher selling price than the buyer whose demand is more elastic.
oSeller must be able to prevent resale (arbitrage) of the product for the buyer’s profit.
oSeller must have some market monopoly power |
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Term
| Monopolistic Competition Characteristics |
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Definition
Large # of small firms in the industry
- # firms is more similar to pure competition than monopoly
- One firm cannot affect the market price or output levels.
- Examples: Small retailers, private practice professionals
Similar, but not identical products produced
- Product Differentiation
o Firms purposely attempt to make their product appear somewhat “different” to buyers.
o Differences can be real quality differences or imagined differences due to packaging
o Product differences allow the seller to charge different prices.
o Examples: Brand names, packaging logos, convenience, location
No collusion nor mutual interdependence between firms
- There are too may small firms in the monopolistically competitive industry for them to collude on price, output, or sales territories
Nonprice Competition and substantial advertising
- A monopolistically competitive firm competes with other firms in ways other than price
o Examples: Brand names, logos, convenience, service, location, et al
- A monopolistically competitive firm often uses some form of low cost advertising.
o Examples: Flier/posters, yellow pages
Easy for firms to enter/exit the industry
- Monopolistically competitive firms are relatively small firms and it does not take a huge amount of financial capital to set up operation.
- Short-run profits being earned by firms will encourage more firms to enter an industry.
- Short-run losses will result in firms leaving the industry. |
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Term
| Similarities of Monopolistic Competition & Pure Competition |
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Definition
- Large # of small firms comprising an the industry
- Easy entry/exit of firms into/out of an industry
- Long-run: Only a normal profit is possible |
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Term
| Similarities of Monopolistic Competition & Monopoly |
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Definition
- Product differentiations
- Non-constant prices
- Downsloping AR and MR curves, AR ≠ MR |
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Term
| Excess capacity (wastes of monopolistic Competition): |
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Definition
- Monopolistically competitive industries are overcrowded with underutilized firms
- Consumers may be willing to pay a slightly higher price for product differentiation options. |
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Term
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Definition
- It informs buyers about product differences & characteristics
- May encourage competition/development amongst sellers
- May increase seller employment if more of product is demanded |
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Term
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Definition
- May be primarily persuasive rather than informative advertising
- May detract from the environment
- May increase the selling prices to cover costs of advertising |
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Term
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Definition
Small # of large firms in the industry
- Just a handful of firms. Concentration ratios measure the fewness of firms
o 4-firm concentration ratios: Measures the % of the total sales made by the four largest firms in a n industry
o 8-firm concentration Ratios: Measures the % of the total sales made by the eight largest firms in an industry.
o Approximately ½ of manufacturing industries in the U.S. have 4-firm concentration ratios ≥ 40 and are considered to be in an oligopoly industry.
i.e. Oil, breakfast cereals, autos, large appliances beer, steel, aluminum, motorcycles, cigarettes, fast food, restaurants, et al. |
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Term
| Differentiated Oligopolies |
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Definition
- Produce differentiated consumer products
- Examples: Autos, cereals, cigarettes, beer, large appliances |
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Term
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Definition
- Produce identical industrial products
- Examples: Steel, aluminum, copper cement |
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Term
| Mutual Interdependence between Firms |
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Definition
- Pricing and output decisions of one firm will affect the other oligopoly firms in the industry.
- Mutual interdependence explains the shape of the “kinked” demand curve of a noncollusive oligopoly
o In hopes of gaining/maintaining market share, oligopoly firms are more likely to follow price cuts by rival firms than price increases. |
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Term
| Nonprice Competition and substantial advertising |
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Definition
| - Oligopolies, like monopolistically competitive firms, compete with other firms in ways other than price. |
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Term
| Obstacles for firms to enter the industry |
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Definition
- Similar to a monopoly industry, it is difficult for new firms to enter an oligopoly industry.
- Oligopolies have frequently grown to their current size through mergers/ acquisitions with other firms
- Large firms produce higher output levels and can achieve economies of scale
- Difficult for small firms to achieve economies of scale and compete |
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Term
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Definition
- The few firms in the industry do not formally set price, output, or sales territories
o Noncollusive oligopolies have a “kinked” demand (D=AR) curve and a discontinuous marginal revenue (MR) curve.
o MR=MC determines price and output levels |
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Term
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Definition
| The few firms in the industry band together and formally set price, output, or sales territories. |
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Term
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Definition
- Cartels are the most comprehensive form of outright collusion between oligopoly firms.
- The Organization of Petroleum Exporting Countries (OPEC) is a cartel of eleven petroleum producing countries. Other foreign cartels: bananas, citrus fruits, diamonds, coffee.
- Collusive oligopolies exhibit characteristics of a monopoly. |
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Term
| What does it take for a cartel to earn monopoly profits? |
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Definition
- Cartel firms must be few in #, but control bulk of production.
- Product must be homogeneous and without close substitutes
- Sales territories and production quotas must be set
- Relatively inelastic market demand for product
- Cheating by cartel members must be prevented |
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Term
| How do cartels fail to earn monopoly profits? |
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Definition
- Unable to prevent cheating by cartel members.
- Unable to prevent entry of new producers into the market
- Decreasing market demand for the product
- Legal obstacles and anti-trust laws |
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Term
| How does a dominant noncollusive oligopoly firm dominant an industry? |
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Definition
- The dominant (largest) oligopoly firm initiates a price change and the other oligopoly firms automatically follow
- No formal agreements nor outright collusion involved
- Failures of price leadership tactics result in price wars.
- Examples: Used in auto, steel, fertilizer, coal, copper industries. Pricewar amongst breakfast cereal producers in 1996 |
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