Test 3 Study Guide

Chapter 12 Production and Cost Analysis I

Production
Firm

Virtual Firms
Profit
Implicit Costs
Total Cost

Total Revenue

Economic Profit
Long-run decision
short-run decision

Production Table

Transformation of factors into

goods and services.
An economic institution that
transforms factors of production
into goods and services.
1) Organizes factors of
production and/or
2) produces goods and/or
3) sells produced goods to
individuals, businesses, or
government.
(The firm plays the same role in
theory of supply that the
individual does in the theory of
demand. Individuals maximize
utility, firms maximize profit.)
Dont produce anything; they
simply subcontract out all
production.
= Total Revenue Total Cost
include the opportunity costs of
the factors of production provided
by the owners of the business.
Explicit payments to the factors of
production plus the opportunity
cost of the factors provided by the
owners of the firm
The amount a firm receives for
selling its product or service plus
any increase in the value of the
assets owned by the firm.
= (Explicit and implicit revenue)
(Explicit and implicit cost)
A firm chooses among all possible
production techniques.
All inputs are variable
a firm is constrained in regard to
what production decisions it can
make.
Some inputs are fixed.
A table showing the output

resulting from various

combinations of factors of
production or inputs.
Marginal Product
Average Product
Production Function

Law of diminishing marginal

productivity

Fixed Costs
Variable Costs
Total Cost
Average Total Cost

Average Fixed Cost

Average Variable Cost
Marginal Cost

MC > ATC
MC = ATC
MC < ATC

The additional output that will be

forthcoming from an additional
worker, other inputs constant.
Output per worker
The relationship between the
inputs (factors of production) and
outputs. Tells the maximum
amount of output that can be
derived from a given number of
inputs.
States that as more and more of a
variable input is added to an
existing fixed input, eventually the
additional output one gets from
that additional input is going to
fall.
Costs that are spent and cannot
be changed in the period of time
under consideration.
Costs that change as output
changes.
Sum of the fixed and variable
costs:
TC = FC + VC
Equals total cost divided by the
quantity produced.
ATC = TC/Q
ATC = AFC + AVC
Equals fixed cost divided by
quantity produced.
AFC = FC/Q
Equals variable cost divided by
quantity produced.
AVC = VC/Q
The increase (decrease) in total
cost from increasing (decreasing)
the level of output by one unit.
MC = Change in Total Cost
ATC is rising
ATC is at its lowest point
ATC is falling

MC > AVC
MC = AVC
MC < AVC

AVC is rising
AVC is at its lowest point
AVC is falling

Chapter 13 Production and Cost Analysis II

Technically Efficient
Economically Efficient
Economies of Scale
Invisible setup cost

Minimum efficient level of

production
Diseconomies of Scale

Monitoring Costs

Team Spirit
Constant Returns of Scale
Envelope Relationship

As few inputs as possible are used

to produce a given output.
the method that produces a given
level of output at the lowest
possible cost.
when long-run average total costs
decrease as output increases
The cost of an invisible input for
which a certain minimum amount
of production must be undertaken
before the input becomes
economically feasible to use
The amount of production that
spreads setup costs out
sufficiently for a firm to undertake
production profitability.
When long-run average total costs
increase as output increases.
1) As the size of the firm
increases, monitoring costs
generally increase.
2) As the size of the firm
increases, team spirit or
morale generally decreases.
The costs incurred by the
organizer of production in seeing
to it that the employees do what
theyre supposed to do.
The feelings of friendship and
being part of a team that bring out
peoples best efforts.
Where long-run average total
costs do not change with an
increase in output.
The relationship between long-run

Entrepreneur

Economies of Scope

Learning by Doing

Technological Change

Depreciation

and short-run average total costs.

An individual who sees an
opportunity to sell an item at a
price higher than the average cost
of producing it.
(organizer of production)
When the costs of producing
products are independent so that
its less costly for a firm to
produce one good when its
already producing another.
As we do something, we learn
what works and what doesnt, and
over time we become more
proficient at it.
An increase in the range of
production techniques that leads
to more efficient ways of
producing goods as well as the
production of new and better
goods.
A measure of the decline in value
of an asset that occurs over time.

Chapter 14 Perfect Competition

Perfectly Competitive Market

Price Taker
Barriers to entry

A market in which economic forces

operate unimpeded.
1) both buyers and sellers are
price takers
2) the number of firms is large
3) there are no barriers to
entry
4) firms products are identical
5) there is complete
information
6) selling firms are profitmaximizing entrepreneurial
firms
A firm or individual who takes the
price determined by market
supply and demand as given
Social, political, or economic
impediments that prevent firms

Marginal Revenue
Marginal Cost
Profit-maximizing output

Profit-maximizing condition
Marginal cost curve
Shutdown point

Market Supply Curve

Normal Profit

from entering a market

The change in total revenue
associated with a change in
quantity
the change in total cost
associated with a change in
quantity
All you need to know is MC and
MR to determine.
A firm should produce where
marginal cost equals marginal
revenue.
MC = MR = P
Is the supply curve
That point below which the firm
will be better off if it is temporarily
shuts down than it will if it stays in
business. When price falls below
the shutdown point, the average
variable costs the firm can avoid
paying by shutting down exceed
the price it would get for selling
the good. When the price is
above average variable cost, in
the short run a firm should keep
on producing even though it's
making a loss.
The horizontal sum of all the firms
marginal cost curves, taking
account of any changes in input
prices that might occur.
**As the short run evolves into the
long run, the number of firms in
the market can change. As more
firms enter the market, the market
supply curve shirts to the right
because more firms are supplying
the quantity indicated by the
representative marginal cost
curve. Likewise, as the number of
firms in the market declines, the
market supply curve shifts to the
left.
The amount the owners of a
business would have received in

Long-run supply curve

Chapter 15 - Monopoly
Monopoly
MR > MC
MR < MC
MC = MR
Monopolists profit

Patent

Price-discriminate

the next-best alternative

Is horizontal because factor prices
are constant and there are
constant returns of scale

A market structure in which one

firm makes up the entire market
The monopolist gains profit by
increasing output
the monopolist gains profit by
decreasing output
The monopolist is maximizing
profit
can be determined only by
comparing average total cost to
price. Befor determining profit,
average total cost curve must be
added. Important to follow this
sequence when finding profit:
1) draw the firms marginal
revenue curve.
2) determine the output the
monopolist will produce by
the intersection of the
marginal cost and marginal
revenue curves.
3) Determine the price the
monopolist will charge for
that output (remember, the
price it will charge depends
on the demand curve)
4) Determine the monopolists
profit (loss) by subtracting
average total cost from
average revenue (P) at that
level of output and
multiplying by the chosen
output.
Legal protection of a technical
innovation that gives the person
holding it sole right to use that
innovation.
to charge different prices to

Natural monopoly

different individuals or groups of

individuals (for example, students
as compared to businesspeople)
1) movie theatres give
discounts to senior citizens
and children
2) airline supersaver fares
include Saturday-night
stayovers
3) automobiles are seldom sold
at list price
4) tracking consumer
information and pricing
accordingly
an industry in which a single firm
can produce at a lower cost than
can two or more firms

Chapter 16 Monopolistic Competition and Oligopoly

Market Structure

Refers to the physical

characteristics of the market
within which firms interact.
Monopolistic Competition
A market structure is which there
are many firms selling
differentiated products and few
barriers to entry
Oligopoly
A market structure in which there
are only a few firms and firms
explicitly take other firms likely
response into account
Characteristics of Monopolistic
1) many sellers
Competition
2) differentiated products
3) multiple dimensions of
competition
4) easy entry of new firms in
the long run
Downward-sloping demand
curve

Monopolistic Competitor in

In making decisions about output,

the monopolistic competitor will,
as will a monopolist, face a
marginal revenue curve that is
below price.
(P = ATC) >/= (MC = MR)

long-run equilibrium
Strategic decision making
Cartel model of oligopoly

Implicit collusion

Contestable market model

North American Industry

Classification System (NAICS)

Concentration Ratio
Herfindahl ratio

Taking explicit account of a rivals

expected response to a decision
you are making
A model that assumes that
oligopolies act as if they were
monopolists that have assigned
output quotas to individual
member firms of the oligopoly so
that total output is consistent with
joint profit maximization.
Multiple firms make the same
pricing decisions even though
they have not explicitly consulted
with one another.
A model of oligopoly in which
barriers to entry and barriers exit,
not to the structure of the market,
determine a firms price and
output decisions.
An industry classification that
categorizes industries by type of
economic activity and groups
firms with like production
processes.
The value of sales by the top firms
of an industry stated as a
percentage of total industry sales.
An index of market concentration
calculated by adding the squared
value of the individual market
shares of all the firms in the
industry.