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ECO 105: EXAM 3
Production Function (Definition)
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Relationship between the quantity of inputs a firm uses and the quantity of output it produces.
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Production Function
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Output= Y(K,L) << Product Function
- K - Capital
- L - Labor
- K & L represent input
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MPL (Marginal Product of Labor)
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Change in quantity of output/Change in quantity of labor - (Change in quantity of output generated by one additional unit of labor.)
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MPK (Marginal Product of Capital)
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Change in quantity of output/Change in quantity of capital
- (Change in quantity of output generated by one additional unit of capital.)
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Law of Diminishing returns
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Increase in quantity of that input, holding levels of all other inputs fixed, leads to a decline in the marginal product of that input. (Increasing at a decreasing rate).
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What happens when technology improves?
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Every worker can produce more output, shifts the curve up.
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Marginal Cost
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The change in total cost when quantity produced goes up by 1 unit. (Change in TC/Change in quantity)
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Marginal Revenue
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The change in total revenue due to a one unit increase in quantity sold.
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Fixed Cost
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Does not depend on the quantity of output produced. (Ex. Rent)
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Variable Cost
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Depends on the quantity of output produced.
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Profit
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=Total Revenue - Total Cost
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Total Cost
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TC = FC+VC
the market value of all the inputs that a firm uses in production
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Change in Profit
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=MR - MC
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Total Revenue
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TR=PQ
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Average total cost
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ATC=TC/Q
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Average Variable cost
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Variable cost per unit of output.
AVC=VC/Q
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Average Fixed Cost
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fixed cost per unit of output.
AFC=FC/Q
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Why does the MC intersect ATC at a minimum?
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- If MC>ATC, it pulls the average down.
- If MC<ATC, it pulls the average up.
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Perfectly Competitive Market
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- Both consumers and producers are "Price-Takers" (Their actions do not influence price).
- Many Identical Consumers/Producers.
- Free entry and exit from the market.
- Goods are similar (Easily substituted).
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Price Takers
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Consumers/Producers actions do not influence the market.
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Is Microsoft a Price Taker?
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No |
MR=MC
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Profit is Maximized (In a perfectly competitive market when MC is increasing)
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Shutdown Price
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MC=AVC
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Breakeven Point
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MC=ATC
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Short-run supply curve
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Shows how the quantity supplied by an industry depends on the market price given a fixed number of producers. (Where MC is increasing past AVC).
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What will happen in the long run?
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Entry will continue until all profit is exhausted.
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Monopoly
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- Only one producer.
- Price setter
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Oligopoly
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Few large sellers.
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Monopolistic Competition
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many companies sell products that are similar but not identical, because of branding, marketing, etc...
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Market Demand Curve
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Demand curve to monopolists.
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MR Curve in Monopoly
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Lies below Demand curve
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Natural Monopoly
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arise because there are cost cost and efficiency gains to be made by having one big producer instead of many small ones. (often regulated by govt.)
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HHI (Herfindahl Index)
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- Determines market power/competition
- Major factor in deciding legality of mergers
- < 1000: Market not concentrated. Merger not likely to be challenged
- 1000 < x < 1800: Only challenged if the merger would increase HHI by more than 100
- x > 1800: Merger likely to be challenged and opposed
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Lerner Index
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- Describes firm's market power.
- As Lerner increases we move away from perfect competition.
- When P=MC, Lerner=0
- (L=P - MC/P)
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What is MC for Monopoly?
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Supply Curve
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Cartels
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- Formed in Monopolistic competition between firms.
- When firms act together and behave like one big producer and charge monopoly prices.
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Price War
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If oligopolies cut corners by producing more than agreed during cartel in an attempt to increase revenue at the expense of others, this drives the price to perfect competition levels.
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Durable goods
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Things people stop buying first. (Electronics, TVs, Fridges, Cars, etc...)
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CCI (Consumer Confidence Index)
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- Important measure of general optimism in the economy.
- Do not want it to dip.
- usually flat.
- "Sticky" (If it is high it will stay there, and if it is low it will stay there)
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Business Cycle
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- Peaks and troughs
- shows recessions and expansions
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Depression
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Severe recession
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Boom
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Prolonged expansion
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Classical Economic Thought
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- Don't like govt intervention
- View recession and expansion like natural phenomenon
- Market will correct its self
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Keynesian Economic Thought
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- Pro govt intervention, govt should play active role.
- During Recession govt should increase spending
- Believe markets do not always correct themselves.
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GDP (Gross Domestic Product)
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Measures the total value of all final goods and services in the economy during a given year.
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Components of GDP
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= C + I + G
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C (GDP)
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-Consumption by households.
- Approx 65%
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I (GDP)
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- Investments by businesses
- Approx. 15%
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G (GDP)
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- Government Expenses.
- Approx. 20%
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GNP
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=C+I+G+(Exp.-Imp.)
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Real GDP
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Uses prices from selected base year. (Main measure of economic well-being)
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Nominal GDP
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Uses current price in the year in which output is produced.
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