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Fully comprehensive exam review guide for ECON 211...

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Econ 211 Exam 2 Study Guide (2019 Fall) Chapter 6 Consumer Choice and Demand Budget Line: illustrates t he possible combinations of two goods that can be purchased with a given income and the prices of each good. ●

Know where the end points come from on a budget line- be able to figure out the price if given the end points and the budget.

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Understand how changes in prices and income shift the budget line.

Budget Line Changes: ●

Changes in prices of one good can cause the line to pivot in/out

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Changes in income s hifts the line in/out

 Utilities: a hypothetical measure of the satisfaction one receives from consuming a good or service ●

Understand how marginal utility is derived from total utility.

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Define law of diminishing marginal utility and recognize it on a graph.

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Find the combination of goods that maximizes utility using MUa/Pa=MUb/Pb.

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If you are given values for MU/P for two goods that are not equal, decide which good to consume more in order to maximize utility.

Total Utility: the total satisfaction from consuming a given quantity of a good or service Marginal Utility: the additional satisfaction from consuming one more unit of a good or service ●

Marginal Utility Analysis: studies consumer  decision making in the face of b  udget constraints

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Asserts that rational consumers  will allocate their incomes to maximize their own well-being

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Determines at which point on the budget line one consumes to maximize utility

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Law of Diminishing Marginal Utility: as one consumes more of a given product, the additional satisfaction from each additional unit falls

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Utility Maximization Rule: individuals maximize total satisfaction when consuming where the marginal utility per dollar is equal for all goods and services -

For goods a,b, … n (P = price):

-

MUa = MUb = . . . = MUn Pa

Pb

Pn

Behavioral Economics ●

Understand the 5 psychological factors that impact behavioral economics

Five Psychological Factors Influencing Economic Behavior: 1. Sunk Cost Fallacy: decisions are influenced by costs already incurred instead of how the decision affects current well-being (refusing to drop a class b/c tuition is already paid) 2. Framing Bias: techniques used to steer individuals to making one decision over another (sales/discounts) 3. Overconfidence: (ex: ambition exceeds follow-through and then gym memberships go unused) 4. Overvaluing the Present Relative to the Future: (ex: not saving enough for retirement) 5. Altruism: (why do people leave generous tips if it does not affect quality of service provided)

Chapter 7 Production and Costs Three Types of Firms ●

Know the pros and cons of the three types of firms (sole proprietorship, partnership and corporation)

Sole Proprietorships ●

One owner and easiest to start (pro)

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Limited financial capital access

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Unlimited liability (con)

Partnerships: ●

More than one owner

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Can divide tasks among partners (pro) o

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Division of labor

Personal assets of all owners subject to unlimited liability (con) o

Includes negligence by partners

Corporations: ●

Owners called stockholders

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Have legal rights (like an individual)

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Can raise money by issuing stocks and bonds (pro)

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Owners protected by limited liability (pro) o

Losses limited to value of stock



Types of Costs & Profit ●

Difference between implicit and explicit costs in economics

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Define accounting profits vs economic profit vs normal profits.

Economic costs include both: -

Explicit Costs: expenses paid directly to some entity (wages, lease payments, raw materials, taxes)

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Implicit Costs: opportunity costs of using resources (depreciation, asset, depletion, forgone wages)

Accounting Profit: include only explicit costs

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Total Revenue minus Explicit Costs

Economic Profit: -

Total Revenue minus Explicit Costs minus Implicit Costs

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A firm earns economic  profit when profits > 0 (after implicit costs)

Normal Profit: equals an economic profit of zero Normal Rate of Return: the return sufficient to keep investors satisfied; it therefore represents the opportunity cost of capital 

Short Run and Long Run ●

Know that in the short run at least one input is fixed and in the long run nothing is fixed.

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Be able to graph Marginal Product curve from a total product curve.

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In the short run, TC=FC+VC.

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How is a sunk cost different from a fixed cost?

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Understand the relationship between marginal cost and average cost.

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Be able to draw a general graph using MC, ATC and AVC.

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Understand economy/ diseconomy of scale and constant returns to scales

Short Run: period when at  least one factor of production is fixed  and cannot be altered -

Plant capacity is f ixed

Long Run: period sufficient for a firm to adjust all factors of production, including plant capacity -

Firms can enter  or exit the industry

Production: the process of turning inputs into outputs. The cost structure depends on the nature of the production process Production in the Short Run: -

Marginal Product: the change in output resulting from one unit increase in labor (changeQ/changeL) -

Initially rises as more workers are hired, then falls as diminishing returns set in

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Average product: total output divided by the amount of labor input (Q/L)

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Diminishing returns to labor occur as more workers are used. If too many workers are used, negative returns to labor can result

Production Costs in the Short Run: -

Fixed costs (overhead): do not vary with the quantity produced -

Ex: building a cruise ship does not depend on number of passengers

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Variable costs: rise as level of output increases -

Ex: food prep on a cruise ship does depend on number of passengers

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Total Costs: sum of fixed and variable costs -

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TC = FC + VC

Sunk Costs: already incurred; cannot be recovered. Rational decisions about future profits ignore sunk costs

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Marginal Cost: change in total cost from the production of one more unit of output (MC = changeTC / changeQ)

-

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Average Cost: m  easure of productivity (in terms of cost efficiency) -

Average Fixed Cost: FC/Q

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Average Variable Cost: VC/Q

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Average Total Cost: TC/Q

Both the AVC and ATC curves are U-shaped -

At low production levels, curves slope downward, reflecting increasing returns as average costs fall

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As production rises, diminishing returns set in, and average costs rise

Production Costs in the Long Run: -

All inputs can be adjusted; therefore, no fixed costs -

Firms choose the appropriate plant size for their market and can adjust as output levels change

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Each plant size is associated with unique long-run cost structure

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As a firm’s output increases, its long run average total costs tend to fall. Economies  of scale result from:

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Specialization of labor and management

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Better use of capital

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Complementary production techniques

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Examples include: Sam’s Club, Costco, and IKEA

As firms continue to grow, they eventually encounter d  iseconomies of scale as average total costs rise due to:

-

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Increased bureaucracy in management

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Increased cost of a scarce resource used in production (Ex: Titanium in aircraft production)

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Increasingly difficult terrain or rising operational costs

Economies of Scope: producing interdependent products (as does Procter & Gamble) helps to reduce production and marketing costs

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Technology alters the shape of the long-run ATC curve -

Enhances production techniques

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Improves global communications

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Provides computing power for easier expansion and economies of scale 

Chapter 8 Perfect Competition Market Structure Analysis ●

Be able to categorize different market structure. 

By observing a few industry characteristics, we can predict pricing  and output behavior. Market structure depends on: -

Number of Firms

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Nature of Product



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Barriers to Entry

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Control Over Price

Primary Market Structures: ●

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Perfect Competition ( ex: corn & wheat industries) o

Many buyers and sellers

o

Homogeneous (standardized) products

o

No barriers to market entry/exit

o

No long-run economic profit

o

No control over price

Monopolistic Competition ( ex: the restaurant industry) o

Many buyers and sellers

o

Differentiated products

o

Little to no barriers to market entry or exit

o

No long-run economic profit

o

Some control over price

Oligopoly (Ex: Samsung and Apple / The automobile industry) o

Relatively few firms

o

Interdependent decision making

o

Substantial barriers to market entry

o

Potential long-run economic profit

o

Shared market power

o

Considerable control over price

Monopoly (ex: the NFL) o

One firm

o

No close substitutes for product

o

Nearly insuperable barriers to entry

o

Potential long-run economic profit

o

Substantial market power and control over price



Perfectly Competitive Markets ●

Understand the profit maximization criterion for perfect competition (MR=P=MC)

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Understand the individual demand curve each firm is facing in perfect competitive market.

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Be able to find out profit maximizing price and quantity and profit on a graph.

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Understanding earning normal profits in the long run is the same as zero economic profits.

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Know why when price goes below minAVC, a firm is better off shutting down.

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Understand why the MC curve above minAVC represents a firm’s short run supply curve.

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Understand that in the long-run price=minATC for perfect competitive firm

Perfectly Competitive Markets: each firm is a price taker (They take the price as given) -

Individual firms get their prices from the market because they are so small that they cannot influence the market price.

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In a competitive market, the price is always equal to marginal revenue

Marginal Revenue: the change in total revenue (TR) that results from the sale of one additional unit of product -

Total Revenue = P x Q

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Marginal Revenue = changeTR / changeQ

Profit Maximization Rule: a firm maximizes profit by producing at the point where marginal revenue equals marginal cost (MR = MC) -

We first focus on short-run (fixed plant size) profit maximization

(How firms make decisions in the short run and long run are in photos on phone) Long run: perfectly competitive firm earns zero economic profit in long run -

Note: zero economic profit (a normal profit) can still be a substantial accounting profit

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The supply curve will shift to the right in the market curve as firms are earning profit (above the ATC) && shift to the left as firms incur a loss (back to ATC minimum) -

It shifts until there is no profit (operating at the price of minimum ATC)



Chapter 9 Monopoly Monopolies ●

Market power is the ability to price above MC.

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Know the three sources of market power.

Characteristics of a Monopoly: -

One firm

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No close substitutes

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Significant barriers to entry

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Potential long-run economic profit

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Substantial market power and control over price (monopolists are Price Makers)

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Create benefits through innovation with new products and technologies

Sources of Market Power 1. Control of a key input of production 2. Economies of scale: large fixed costs 3. Government protection with patents and copyrights Monopoly and Marginal Revenue: -

A monopoly’s demand curve is the market demand curve. To sell more quantity, it must lower the price on all units. Marginal Revenue = changeTR / changeQ -

Example MR of 11th unit is $18: P = $40, Q = 10; TR = $400 P = $38, Q = 11; TR = $418

Profit Maximization: -

Monopolies maximize profit the same way as competitive firms, by using the profit-maximization: -

Profit is maximized at the quantity at which MR = MC and the price up at the demand curve

Five Steps to Maximizing Profit: 1. Find MR = MC 2. Find Optimal Q 3. Find Optimal P 4. Find ATC 5. Find Profit ●

Use the 5 steps to find profit maximizing price and quantity, and profit using a table.

Comparing Monopoly and Competition: -

Under conditions of monopoly, the price  is higher and output  is lower t han under conditions of competition.

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This creates inefficiency in the market known as deadweight loss

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Understand the loss of efficiency (DWL) with a monopoly compared to perfect competition.

Inefficiencies of Monopoly: -

Rent Seeking: costly actions (such as lobbying) taken to avoid or limit competition

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X-Inefficiency: occurs when monopolies squander (such as lavish retreats and perks)

Price Discrimination: charging different prices to different customers -

Conditions for Price Discrimination: 1. Must have some c ontrol over price 2. Must be able to separate  the market into groups based on elasticities of demand 3. Must be able to prevent  arbitrage (UT games checking for ID)

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Types of Price Discrimination: o

1st Degree: firms capture all  of consumer surplus by charging each consumer his or her maximum WTP

o

2nd Degree: charging different prices b  ased on the quantity purchased ▪

Rationale: Cost of selling many units to one consumer is often less than that of selling a single unit to many ●

If discounts convince consumers to buy more than intended, profits can be earned as long as discount price exceeds marginal costs

o

3rd Degree: charging different prices to different groups of consumers with varying elasticities

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Know three types of price discrimination

Natural Monopoly: a monopoly with large economies of scale, often protected by the government, such as the U.S. Postal Service Regulating Natural Monopolies: -

of scale, such that one A natural monopoly has significant economies  firm is more cost efficient than two or more

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To prevent a natural monopolist from exploiting its market power, government uses regulation such as: -

Average Cost Pricing Rule:

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Often forced to charge a price  equal to ATC, which is more than the competitive price but less than the monopoly price (causing zero economic profit)

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Rate of Return Regulation: -

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Pricing that allows the firm to earn a normal  return on investment

Price Cap Regulation: -

Maximum prices that firms can charge, adjusted to cost conditions

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What is a natural monopoly.

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What are the regulations government can use to regulate natural monopoly.

Antitrust Policy: the goal of antitrust policies and laws is to preserve competition and prevent monopolies with their maximum market power from arising in the first place ●

Major Antitrust Laws: o

The Sherman Act (1890): provides criminal penalties for attempts to monopolize

o

The Clayton Act (1914): forbids contracts and other arrangements that limit competition

o

The Federal Trade Commission Act (1914): protects consumers from unfair or deceptive practices

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Know about the important antitrust laws.

Monopoly Power increases at it becomes more concentrated: ●

Four-Firm Concentration Ratio is the share of industry sales accounted by the four largest firms (add the four biggest and then divide by the total sum)

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Herfindahl- Hirschman Index (HHI): the main measure of market concentration used to evaluate mergers and judge monopoly power o

The sum of the squares of market share held by each firm (0-10,000) ▪

HHI < 1,500 Unconcentrated

▪

1,500 < HHI < 2,500 Moderately Concentrated

▪

HHI > 2,500: Highly Concentrated

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Understand and be able to calculate C4-four firm concentration ratio.

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Understand and be able to calculate Herfindahl-Hirschman Index(HHI).

Chapter 10 Monopolistic Competition and Oligopoly Monopolistic Competition c haracteristics include: ●

Many buyers and sellers

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Differentiated products o

Key to monopolistic competition b/c gives the firm some control over price (market power)

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No barriers to market entry or exit (key difference to oligopoly)

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No long-run economic profit

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Some control over price

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Downward, relatively flat (elastic) demand curve

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Example: restaurant industry

Characteristics of a Monopoly: