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159 Cards in this Set

  • Front
  • Back
Explicit Cost
cost that involves actual spending (outlaw) of money

*ex. tuition of additional year of school*
Implicit Cost
does not require outlay of money---
Measured by the value of the benefits given up (in $ terms)

*Ex. another year in school includes $ you would've earned at a job instead
Accounting Profit
includes explicit cost & depreciation [reduction in value]


*ex. kathy makes $100,000 w/ $60,000 in expenses.

100,000 (revenue)
-60,000 (explicit cost)
-5,000 (depreciation)

=35,000 (accounting profit)
Economic Profit
includes opportunity cost (can include implicit & explicit cost)

[usually less than accounting profit]

100,000 (revenue)
-60,000 (explicit cost)
-5,000 (depreciation)

=35,000 (accounting profit)
-3,000 (income could've earned using capital differently [implicit])
-34,000 (income could've earned as manager instead of owning own store [implicit])

= -2,000 (ECONOMIC PROFIT)
Capital
the value of a businesses assets

-tools, equipment, buildings
Implicit Cost Of Capital
opportunity cost of a capital used by business

(the income you could've gotten from teh capital if it was used in a different way)
***EX. Rent instead of Own***
Marginal Analysis
comparing the marginal benefit & the marginal cost
Marginal Benefit
the benefit of doing a little bit more of something

(the additional benefit associated with a 1 unit increase in the level of activity)
Marginal Cost
the cost of doing something a little bit more

(the increase in someone's cost when they do one more of something)
Increasing Marginal Cost
when each additional unit of activity costs more than the previous unit

(each additional lawn mowed costs more than the previous one)
Marginal Cost Curve
shows relationship between the marginal cost and the quantity of the activity already done
Decreasing Marginal Benefit
when each additional unit of activity produces less benefit than the previous unit

(the more lawns felix has already mowed, the smaller the marginal benefit from mowing one more)
Marginal Benefit Curve
shows how the benefit from one more unit of activity depends on quantity of that activity already done
Optimal Quantity
the quantity of an activity that generates the max possible net gain

(marginal benefit - marginal cost = net gain)

**on graph, where MB & MC curves intersect is optimal net gain, or optimal quantity.**
Principle of Marginal Analysis
the optimal quantity of an activity is the quantity that
Marginal Benefit = Marginal Cost
Sunk Cost
a cost that has already been incurred & can't be recovered
--Sunk Costs should be ignored in decisions about future actions

(EX. replace brake pads @ $250 then find the whole brake system needs to be replaced (including brake pads). $250 is a SUNK COST.
repair system = $1500
new car = $1600
*saying you should buy a new car bc total repairs cost $1750 is WRONG bc it takes Sunk Costs into consideration*. you should repair the car.)
Interest Rate
the price carged by the lender when you borrow money
(calculated as a % of the amt borrowed)

--allows people to factor out complications of time in the present-future value of $1
Present Value
the value to you today of $1 realized one year from now

$1/(1+r)
the amt of money you must lend out today in order to have $1 in one year
Net Present Value
the present value of current and future benefits minus the present value of current and future costs

(current benefits + future benefits)-
(current costs + future costs)
= Net Present Value
Present Value Formula for
Multiple Years / Multiple Payments
1/(1+r)^t
utility
measure of satisfaction a consumer derives from consumption of goods/services
consumption bundle
the set of all goods/services an individual consumes
utility function
relationship between a consumption bundle and the total amt of utility it generates

[personal matter-- different tastes = different utility functions]

*consumption produces utility*
how do u measure utility?
UTILS

[1 unit of utility]
to maximize total utility focus on _____________
marginal utility
marginal utility
change in total utility from consuming one more of something
marginal utility curve
shows how marginal utility depends on the quantity of goods / services consumed

*constructed by plotting points at the midpoint of unit intervals

*downward sloping (each additional unit adds less to total utility than the previous)

*if negative marginal utility ==== consuming it actually reduces total utility
principle of diminishing marginal utility
additional satisfaction consumer gets from additional unit of good/service declines as amt consumed rises

*eventually reach a point where additional unit adds nothing to your satisfaction
budget constraint
the fact that a consumer's consumption bundle can't exceed their income

*consumption bundles are affordable when they obey the budget constraint
consumption possibilities
the set of all affordable consumption bundles

*depend on the consumer's income and the prices of goods/services

*every bundle on or inside the budget line is affordable
budget line
budget line shows consumption bundles when ALL of income is spent

(if not all income is spent the bundle is inside the line)

*downward sloping

(Q of good 1)(P of good 1)
+ (Q of good 2)(P of good 2)
===========================
INCOME

*to find intercepts of budget line (when all income spent on 1 good & 0 on the other):
(Q of good 1)=(income)/(P of good 1)

*further the budget line from the origin = higher the income
the slope of the budget line shows:
the opportunity cost of an individual consuming an additional unit of a good in terms of how much of the other good mst be forgone

*the scarce resource is $$
"relative price"
number of good 1 that must be forgone to obtain one more of good 2

(it is in terms of the good thats being given up)
a larger income...
increases consumption possibilities & total utility

(& moves budget line further from origin)
optimal consumption bundle
the consumption bundle that maximizes total utility given the budget constraint

*the point on the budget line that holds the most satisfaction/utility for the person

**point where total utility is greatest**
[total utility = sum of good 1's utility @ pt + sum of good 2's utility @ pt]
total utility function graph
shows vertically plotted total utility (utils) against horizontilly plotted consumption bundles (diff consumption amts of good 1 & good 2)

***optimal consumption bundle is at the top of the curved "total utility curve"
(where curve is at highest vertical pt)
to find optimal consumption bundle we can find where total utility is maximized.... but also BY...
thinking in terms of how much to spend on each good

--HOW to spend the marginal Dollar (how to allocate the dollar between the 2 goods at hand)
marginal utility per dollar
how much additional utility you get from spending an additional dollar on either good

(marginal utility of the good)/(price of good in dollars)

==MU/P

*falls as quantity consumed rises* (bc marginal utility falls as Q consumed rises)
[diminishing marginal utility]
optimal consumption bundle by marginal utility per dollar
marginal utility per dollar spent is the SAME for both goods at the optimal consumption bundle

optimal consumption bundle:
MU1/P1=MU2/P2

*when marginal utility per dollar on good one is 3 and good two is 1 then you're consuming too many of good two*
optimal consumption rule
to maximize utility with a budget constraint the marginal utility per dollar spent on each good in the consumption bundle is the same
Individual Demand Curve
shows relationship between the Q of a good demanded and the market price of the good

(how many of good 1 you'll buy at a given price)
market demand curve
shows how Q of a good demanded depends on the market price of the good

(market price is the sum of of the individual demand curves for all consumers)
-->person 1 demands 1 lb, person 2 demands 2 lbs, =>Q demanded by market is 3 lbs
law of demand
as price increases the Q demanded decreases

*the individual demand curve is downward sloping, obeying the law of demand
how does the price of a good affect MU {marginal utility} & MU/P {marginal utility per dollar}
the marginal utility doesn't change

rising price = marginal utility per dollar DECREASES
-->gives customer incentive to consume fewer clams

lowering price = marginal utility per dollar increases
substitution effect
the change in quantity consumemd as the consumer substitutes the good thats cheaper for the good thats more expensive

--when the good absorbs SMALL share of consumer's spending

*also why individual demand curve slopes downward

*in turn why market demand curve slopes downward
Income effect
the change in Q consumed of the good that results from a change in the consumer's purchasing power due to change in price of the good

-effects goods that account for substantial share of consumers' spending
-housing, food
-doesn't have effect for majority of goods bc most are effected by substitution effect
income effect influencing
NORMAL goods
-reinforces the substitution effect
--->when good taking up a lot of a persons income's price rises person becomes poorer bc purchasing power falls
--->decreases demand for normal goods
--->SO increase in price in large good reduces income reduces Q demanded, & reinforces substitution effect
income effect influencing
INFERIOR goods
-income & substitution effect work in DIFFERENT directions
-the income effect of a price tends to produce an increase in the Q demanded of the inferior good
what effect?:

when housing becomes cheaper people have incentive to substitute housing for other goods in their consumption bundle
SUBSTITUTION EFFECT
what effect?:

when price of housing falls people are in effect, richer
(they feel richer so they buy bigger houses, or more normal goods)
INCOME EFFECT
how do you represent a utility function that takes consumption of both goods into account
"utility hill"

good 1 on horizontal
good 2 on vertical

has contour lines where altitude of hill is constant
indifference curve
the contour line on the utility hill that shows all consumption budnles that yield the same amount of utility

(consumers indifferent between 2 pts on the same contour line bc they yeild the same amt of utility)
indifference curve map
collection of indifference curves (normal 2D)
-each indifference curve corresponds to a different level of utility

*indifference curve above = higher level of utility

*no 2 individuals have same indifference curve maps
properties of indifference curves
*never cross [if crossed then a point would represent two different levels of utility]

*curves farther out yield higher total utility

*curves slope downward bc increasing one good must decrease the other good

*the slope gets flatter as you move down the curve to the right (CONVEX shape) -->means diminishing marginal utility
what happens with utility between good when you move down the indifference curve
the utility you gain from more of one good is equal to the utility you loose from less of the second good

(-change in utility of good one) + (+change in utility of good two)= 0

or

-(MU of good 1)(Q of good 1)
= (MU of good 2)(Q of good 2)

or

-(change in Q 1)/(change in Q 2)
= (MU 1)/(MU 2)

*when consuming a small amt of goods the marginal utility per good is HIGH
equation for change in total utility from changing consumption
(MU of good) x (Q of good)
What condition must be met for total utility level to remain constant along indifference curve
quantity of good one willing to give up in return for good two EQUALS ratio of marginal utility of good one to marginal utility of good two
Marginal rate of substitution (MRS)
substituting good 1 in place of good 2 is equal to
MU 1/ MU 2

***ind. who consumes a lot of A and a little of B will be willing to trade off a lot of A for one more unit of B***

(the ratio of marginal utility of both goods)

***falls as you move down the indifference curve***
diminishing marginal rate of substitution
the more of good 1 a person consumes in proportion to good 2, the less good 2 person is willing to substitute for another unit of good 1
ordinary goods
a pair of goods in a utility function w/ 2 properties::
1)consumer requires more of one good to coimpensate for less of the other

2)the consumer has a diminishing marginal rate of substitution when substituting one good for the other

*marjority of goods
tangency condition
where the budget line (linear) is tangent to the indifference curve (convex) is the point at whcih the OPTIMUM CONSUMPTIOn BUNDLE occurs
slope of the budget line
-N/P1 DIVIDED BY N/P2
=
-P1/P2

(N IS USED FOR INCOME)
relative price

*REAL*
P1/P2

(price of good 1)/(price of good 2)

the rate at which good one trades for good two in the market
relative price rule
at the optimal consumption bundle
MU1/MU2 = P1/P2

(the marginal rate of substitution between two goods is equal to the ratio of their prices

AKA the rate at which you'd trade G1 for more of G2 EQUALS the rate at which the two goods are traded in the market
the relative price rule shows that at the optimal consumption bundle slopes of the indifference curve and the budget line......
ARE THE SAME!!!!

indifference curve and budget line have the same slope at optimum bundle (where budget line is tangent to the indifference curve)
individuals with different preferences have different....
have different utility functions.... then different indifference curve maps with different shapes.... which translate into different consumption choices

*even amoung consumers with the same income facing the same prices*
Perfect Substitutes
-indifference curves are straight lines
-any combination of the 2 goods (that adds to the same amt) yields the same utility
-marginal rate of substitution CONSTANT (always willing to substitute one good for the other no matter how much of one is consumed)
-any increase in price of one good will cause person to switch completely to the other goood (bc marginal rate of substitution doesn't depend on the composition of consumption bundle)
-utility is maximized @ any pt on budget line SO CANNOT PREDICT which bundle she'll choose among the bundles that lie on the budget line.
Perfect Complements
-when a consumer wants to consume two goods in the same ratio, no matter what their prices
(an extra cookie w/o an extra glass of milk yeilds no utility)
-Slope of budget line has no effect on relative consumption of the two goods
-->he'll always consume the two goods in same proportions regardless of prices
-marginal rate of substitution is UNDEFINED bc ind.'s preferences don't allow ANY substitution between goods
-indifference curves are right angles away from the origin
lowering income but relative price remains the same.....
budget line shifts inward due to lower income; slope remains the same due to same relative price
what kind of good:

consume less of both goods when income falls
NORMAL GOODS
(demand decreases when income falls)


*inferior goods=demand increases when income falls*
what makes the budget line change?
if relative price of good in terms of other good changes

--->then chooses new consumption bundle
rise in the price of rooms can make
purchasing power fall making you poorer

--this reduces consumption possibilities & lowering indifference curve

*with raise in housing its as if income declined
movement along the individual dmeand curve shows
substitution effect
how does a lower income affect the budget line
budget line shifts inward but maintains same slope bc relative price hasn't changed
if price of rooms increase and in turn slope becomes steeper...
the quantity of other good u must give up for a room is higher -- opportunity cost has changed

--also u consume less rooms bc a raise in price of rooms makes you poorer.... income hasn't changed but still can't reach same level of utility
(lower indifference curve)
production function
the relationship between quantity of inputs a firm uses and the quantity of output it produces

*the quantity of outputs a firm produces depends on the quantity of inputs
fixed input
an in put whose quantity is fixed and cannot be varied

*ONLY EXIST IS SHORT TERM

ex.....land when only 10 acres are available
variable input
input whose quantity the firm can vary

ex....labor
long run
given a long enough period of time firms can adjust the quantity of any input (even so called "fixed" inputs
short run
the time period in which at least one input is fixed
total product curve
shows how the quantity of output depends on quantity of the VARIABLE input (for a given quantity of the fixed input)
marginal product
the marginal product of an input is the additional quantity of output that is produced by using one more unit of the input

marginal product of labor =
change in Qoutput/
change in Qinput

MPL = change Q / change L
the slope of the total product curve is:
simply the MARGINAL PRODUCT OF LABOR....

change in Qoutput / change in Qlabor
diminishing returns to an input
these exist when an increase in Q of the input (when Q of other inputs are fixed) reduces the inputs marginal product

*Ex. as you add more and more workers w/o increasing acre number each worker is working a smaller share of the 10 acres.... thus the additional worker can't produce as much output as the previous worker
total product curve
shows how the quantity of output depends on quantity of the VARIABLE input (for a given quantity of the fixed input)
marginal product
the marginal product of an input is the additional quantity of output that is produced by using one more unit of the input

marginal product of labor =
change in Qoutput/
change in Qinput

MPL = change Q / change L
the slope of the total product curve is:
simply the MARGINAL PRODUCT OF LABOR....

change in Qoutput / change in Qlabor
diminishing returns to an input
these exist when an increase in Q of the input (when Q of other inputs are fixed) reduces the inputs marginal product

*Ex. as you add more and more workers w/o increasing acre number each worker is working a smaller share of the 10 acres.... thus the additional worker can't produce as much output as the previous worker
fixed cost
doesn't depend on the quantity of output produced
"overhead cost"

(like always having to pay for land you're using)
variable cost
cost that depends on the quantity of output produced (the cost of the variable input)
total cost
fixed cost + variable cost

(total cost of producing
total cost curve
curve showing how total cost depends on the Quantity of output

*slopes upward due to variable cost

*gets steeper (slope is greater as amount of output increases)
[due to diminishing returns to variable input]
marginal cost
change in total cost /
change in Qoutput

MC = change TC / change Q

( slope )

-upward sloping due to diminishing returns to inputs (as output increases the marginal product of the variable input decreases)
-->more and more of the variable input must be used to produce an additional unit of output
flattening of total product curve as output increases is the flip side of
steepening of the total cost curve as output increases
average total cost (aka average cost)
total cost divided by quantity of output produced

ATC = TC / Q

tells the producer how much the typical (avg) unit of output costs to produce

(while marginal costs tell producer how much one more unit of output costs to produce)

ATC = AFC + AVC

fixed cost falls as more output produced & variable cost rises as output is produced (leads to the u-shaped average cost curve)
average total cost curves
u-shaped
-falls at low levels of output then rises at higher levels
average fixed cost
fixed cost per unit of output

AFC = fixed cost / Qoutput
average variable cost
variable cost per unit of output

AVC = variable cost / Qoutput
increasing output has two opposing effects on average total cost:
1)spreading effect:
the larger the output the more production that can "share" the fixed cost--> the lower the average fixed cost
*more powerful at low Q's

2)diminishing returns effect:
the more output produced the more variable input required to produce additional units--> therefore higher average variable cost
*more powerful as Q rises
minimum cost output
The Q that corresponds with minimum ATC

where atc curve is at the bottom of the U
3 things always true about marginal cost and ATC
1)at minimum cost output ATC is EQUAL to marginal cost

2)at output less than minimum cost output marginal cost is less than ATC and ATC is falling

3)when output is greater than minimum cost output, marginal cost is greater than ATC and atc is rising
price taking producers
when their actions cannot affet the market price of a good

(when there's enough competition -in perfect competition- every producer is a price taker)
price taking consumers
a consumer who can't influence the market price
perfectly competitive market
all producers and consumers are price takers

--consumption/production prices by individuals DON'T affect the market price.
perfectly competitive industry
an industry in which producers are price takers

(not all industries are always perfectly competitive, but very rare for consumers not to be price takers)
TWO conditions for perfect competition
1) must have many producers -- none with a large market share
*there's thousands of wheat farmers, none w/large market share [perfectly competitive], but breakfast cereal is dominated by kellogs--they have a large market share [not perfectly competitive]

2)industries' outputs must be a standardized product (aka commodity)
*consumers don't care who the wheat comes from, therefore if one farmer raises wheat price they loose all sales....but kellogs can change price because they're not standardized--NOT perfectly competitive
market share
fraction of total industry output represented by producer's output
standardized product/ aka commodity
consumers regard the products of different producers as the same good
*wheat*
"free entry & exit"
when new producers and enter and leave an industry easily

-most perfectly competitive markets
total revenue equation
TR = P x Q
Profit equation
Profit = TR - TC
marginal revenue
the change in revenue generated by one additional unit of output

MR = change TR / change Q

(marginal revenue = change in total revenue divided by the change in output quantity)
optimal output rule
profit is maximized by producing the quantity of output at which the marginal revenue of the last usit produced is equal to its marginal cost

***when MR = MC***
"price-taking firm's optimal output rule"
a price taking firm's profit is maximized by producing the quantity of output at which the market price is equal to the marginal cost of the last unit produced

***P = MC
@price-taking-firm's optimal Q of output***
marginal revenue curve
marginal revenue varies with output
When is the firm:
[using TR & TC]

profitable
breaking even
incurring a loss
TR > TC : profitable

TR = TC : breaking even

TR < TC : incurring loss
when is the firm:
[using market price & avg total cost]

profitable
breaking even
incurring a loss
P > ATC : profitable

P = ATC : breaking even

P < ATC : incurring loss
PROFIT equation
Profit = (P - ATC)(Q)
break even price
the minimum ATC
-->the price at which it earns zero profits


*firms profits when market price is above break even price & looses when market price is below break even price
RULES for determining whether a producer is profitable depending on comparison of market pice of good and producer's minimum ATC (the break even price)
1)when market price exceeds min ATC = producer is profitable

2) when market price equals min ATC = producer breaks even

3)when market price is less than min ATC = producer is unprofitable
when should a firm be shut down?
when market price is below min average variable cost

[bc there is no level of output at which the firms total revenue would cover its variable costs]
-->profits are maximized by not producing at all
"shut-down price"
the price at which a firm ceases production in the short run

*the MINIMUM AVC*

(when price is greater than min AVC firm should continue producing in short run)
short-run individual supply curve
shows how an individual producer's profit maximizing output quantity depends on the market price (fixerd cost is a given)
industry supply curve
shows relationship between price of good and total output of industry

*tells if an increase in demand will lead to a price increase*

*analyzed differently for short-run/long-run*
short run industry suppply curve
shows how quantity supplied by producers depends on market price (with fixed # of producers)
short run market equilibrium
the Q supplied equals the Q demanded (# producers is given)
long run market equilibrium
when Q supplied equals Q demanded [BUT sufficient time has ellapsed for entry and exit in industry to occur]
-->producers have adjusted to long-run choices.... not incentive for big exits/entries to and from market
long run industry supply curve
shows how Q supplied responds to price
(after producers given sufficient time to enter/exit industry
economies of scale
when long run ATC declines as output increases
deseconomies of scale
when long run ATC increases as output increases
constant returns to scale
when long run ATC is constant as output increases
physical capital
manufactured resources (buildings, machines)
human capital
the improvement in labor created by education and knowledge in the workforce
factor distribution of income
division of total income among labor/land/capital
value of marginal product (VMPL)
the VMPL of a factor is the value of additional output generated by employing one more unit of that factor
VMPL
equation
VMPL = (P)(MPL)
should you hire another worker?

(based on VMPL)
yes if value of extra output is more than cost of worker

VMPL > W
to maximize profit (based on VMPL)
hire workers until for the last worker employed

VMPL = W
value of marginal product curve
shows how value of marginal product of the factor depends on the Q of the factor employed

*downward sloping due to diminishing returns to labor in production
(the marginal product of each worker is less than the previous worker)
factor demand curves shift bc OF::
1)changes in prices of goods

2)changes in supply of other factors
*acquiring more land = each worker produces more = marginal product of labor rises

3)changes in technology
rental rate
(of land or captial) = the cost of using a unit of that asset for a given time
equilibrium value of marginal product
the additional value produced by the lsat unit of that factor employed

(in equilibrium the marginal product of labor will be the same for all employers
marginal productivity theory of income distribution
each factor is paid the value of the output generated by the last unit employed in the factor market as a whole
compensating differentials
wage differences across jobs that reflect the fact that some jobs are less pleasant than others
unions
organizations of workers trying to riase wages / improve working conditions
efficiency wage model
why we may observe wages offered above equilibrium level (incentives for better performance)
time allocation
decisions about labor -- how many hours to spend on different activities
leisure
time available for purposes other than earning money to buy marketed goods
individual labor supply curve
shows how Q of labor supplied by individual depends on the wage rate
shifts in labor supply curve due TO:::
1) changes in preferences/ social norms (women employed)

2)changes in popultaion
(shifts right bc more workers)

3)changes in opportunities
(more jobs available to women than just teachers)

4)changes in wealth (when wealth increases so does consumption of normal goods including leisure)
*income effect caused by change in wealth shifts labor supply curve*
*income effect caused by wage increase is movement along labor supply curve**
you sell photos....
and increase in the price of photos from $10 to $12 will:::
increase the DEMAND FOR LABOR

(meaning the demand curve! not quantity of demand which is a SHIFT up the demand curve)
the long run average cost of producing 100 units OR 110 are both 4$... which shows
CONSTANT RETURNS TO SCALE
the labor supply curve shows a trade off between
WORK & LEISURE
the VMPL is EQUAL TO:
(MP)(P per unit output)
how do you find the AVERAGE PRODUCT ?
TOTAL OUTPUT / Q labor
when wages increase...
the income effect will cause you to work less bc leisure is a normal good

[nothing to do with substitution effect!!!!!]
in the SHORT RUN
which curve declines as more output is produced
AVERAGE FIXED COST
in a perfectly competitive market in the short run when do you shut down business??
when total revenue can't cover total VARIABLE costs
continue hiring workers til....
(MPL)(P) = W