L1 flash cards economics (ss4)


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L1 flash cards economics (ss4)

  1. 1. Market Interactions Interactions of goods and services take place in the marketbetween firms and households. Market interactions are voluntary.Study Session 4, Reading 13
  2. 2. Demand Functions and DemandCurve The Demand Curve is the graphical representation of theDemand Function. The demand curve is the graph of theinverse Demand Function. The Demand Curve shows both the highest price and thehighest quantity that buyers are willing to pay and are willingand able to purchase at for each price.Study Session 4, Reading 13
  3. 3. Demand Functions and DemandCurveThe Demand Curve is governed by the Law of Demand whichsays that as the price of a good rises (falls), the buyers will buyless (more) of it.Study Session 4, Reading 13
  4. 4. Supply Functions and Supply Curve The Supply Curve is the graphical representation of the SupplyFunction. The Supply Function is the mathematical representation ofSupply as the dependent variable, and price as theindependent variable.Study Session 4, Reading 13
  5. 5. Supply Functions and Supply Curve The supply curve is governed by the Law of Supply which saysthat as the price of a good rises (falls), the supplier will sellmore (less) of it.Study Session 4, Reading 13
  6. 6. Changes in Demand vs. Movementalong the Demand Curve A change in price (all other variables being constant) causes achange in demand, known as a movement along the demandcurve or a change in the quantity demanded. A change in any other variable shifts the entire demand curveand is called a change in demand.Study Session 4, Reading 13
  7. 7. Aggregating the Supply andDemand Functions In order to find aggregate demand of the market, all individualbuyer quantities are added together, not the prices. The Market Supply Curve is the aggregate of all individualsellers’ supply curves.Study Session 4, Reading 13
  8. 8. Market Equilibrium Markets achieve equilibrium at the price and quantitycombination which satisfies both the market demand functionand the market supply function. The equilibrium price and supply can be calculated byequating the demand function to the supply function.Study Session 4, Reading 13
  9. 9. Market Mechanism When the market is not in equilibrium, it tends to movetowards equilibrium. In the case of excess supply, prices fall. In the case of excess demand, prices rise. Prices remain unchanged if there is neither excess supply norexcess demand.Study Session 4, Reading 13
  10. 10. Negatively Sloped Demand andSupply Curves When supply and demand curves are negatively sloped andthe supply curve intersects the demand curve from above, themarket mechanism will ensure a stable equilibrium. When the supply curve intersects the demand curve frombelow (a price above the equilibrium) there will be excessdemand and prices will rise further, resulting in an unstableequilibrium.Study Session 4, Reading 13
  11. 11. Non-Linear Supply Curves When supply curves are non-linear, there are twocombinations of prices and quantities that satisfy the demandand supply curves. The lower priced equilibrium is stable because the supplycurve is positively sloped and the demand curve is negativelysloped.Study Session 4, Reading 13
  12. 12. What is Market Interference?Law makers often interfere with the market if they think that theprices are too high for consumers to pay.Study Session 4, Reading 13
  13. 13. Price Ceiling A Price Ceiling is a type of market interference.A maximum price is set for a product which is typically belowthe equilibrium price.Study Session 4, Reading 13
  14. 14. Deadweight Loss Deadweight Loss is the loss of a surplus to any member of theeconomy. That is, it reduces the economic benefit oftransactions. In the example of the price ceiling, the surplus is nottransferred. As a result, there is a loss of surplus, and hencelower economic efficiency.Study Session 4, Reading 13
  15. 15. Price Floor A Price Floor is a lower limit on the price of goods or services. Price floors are typically set above the equilibrium price.Study Session 4, Reading 13
  16. 16. Taxes Per unit tax can be imposed on either the producer orconsumer. Like any form of market regulation, it leads to adeadweight loss.Study Session 4, Reading 13
  17. 17. Taxes of Producers The imposition of tax on producers, increases the marketprice, and reduces the equilibrium quantity. The imposition of taxes on producers shifts the supply curveupwards. Given it results in a lower quantity of equilibriumvolume, it leads to a deadweight loss. Additionally, some ofthe surplus is transferred to the Government.Study Session 4, Reading 13
  18. 18. Taxes on Consumers When unit taxes are imposed on the consumer, it results in adownward shift in the demand curve. Unit taxes on consumers therefore result in a lower quantityequilibrium tax, whereby some of the surplus under a marketequilibrium price (without the tax) is transferred to theGovernment, and some is lostStudy Session 4, Reading 13
  19. 19. Total Revenue Total revenue is derived by multiplying the total units sold bythe price per unit Under perfect competition, for every additional unit sold, thetotal revenue increases by the price of the product.Study Session 4, Reading 15
  20. 20. Average Revenue Average revenue (AR) is the total revenue divided by thequantity sold. It is the average price that a firm receives for selling a productin the market.Study Session 4, Reading 15
  21. 21. Marginal Revenue Marginal Revenue is the additional revenue generated byselling one more unit of the product. It is calculated by dividing the change in total revenue by thechange in the quantity sold.Study Session 4, Reading 15
  22. 22. Factors of Production Land Labour Capital MaterialsStudy Session 4, Reading 15
  23. 23. Total Cost Total Cost is the cost of all of the factors of production. Total Cost is the sum of Total Fixed Costs and Total VariableCost.Study Session 4, Reading 15
  24. 24. Average Cost Average Cost is the average total cost per unit. Average Fixed Cost is the average fixed cost per unit, and iscalculated as Total Fixed Costs divided by the number of units. Average Variable Cost is the Total Variable Costs divided by thenumber of units. Average Total Cost is the total costs divided by the number ofunits.Study Session 4, Reading 15
  25. 25. Marginal Cost Increase in cost for one additional unit Marginal cost at low outputs is low Due to law of diminishing returns it increases How total cost changes as input changes is explained bymarginal costStudy Session 4, Reading 15
  26. 26. Fixed Cost Fixed Costs are the costs of the factors of production thatdon’t vary with the number of units produced. Fixed cost remains constant regardless of the level of outputStudy Session 4, Reading 15
  27. 27. Variable Cost Variable Costs are the costs of the variable factors ofproduction. Total Variable Costs change with the level of output.Study Session 4, Reading 15
  28. 28. Breakeven Point Breakeven occurs when Total Revenue = Total Cost. At breakeven point the price, average revenue and marginalrevenue equal average total cost. The firm makes no profit or no loss at breakeven. New firms bear start-up losses due to lower quantity sold andstruggle to achieve breakeven. They try to reach thebreakeven point as soon as possible .Study Session 4, Reading 15
  29. 29. Shutdown Point At the shutdown point, firms no longer produce. Fixed costs are still borne by the firm. Firm will not shutdown as long as the selling price exceeds thevariable costs per unit. At the Shutdown Point, average revenue is less than averagevariable costs.Study Session 4, Reading 15
  30. 30. Shutdown PointStudy Session 4, Reading 15
  31. 31. Economies of Scale and Effects onCosts Economies of scale refers to the decreasing unit costs as thesize increases. The better use of technology and efficient labour results inlower costs. In the long run, average costs decrease. The minimum point of the Long range average total cost curveis the called minimum efficient scale. It is the optimal firm sizeunder perfect competition.Study Session 4, Reading 15
  32. 32. Diseconomies of Scale and Effecton Costs Under Diseconomies of Scale, unit costs start to rise after acertain level of production. Firms become less efficient with size. It occurs when size cannot be managed efficiently. The result is that average total costs increase in the long run.Study Session 4, Reading 15
  33. 33. Diseconomies of Scale and Effecton CostsStudy Session 4, Reading 15
  34. 34. Profit Maximizing Output Profit is maximized when total revenue exceeds total cost bythe maximum amount. Given technology and physical capital are fixed in the shortrun, the profit maximising level of output is likely to occurwhere some economies of scale benefits are present. Economic profit is the vertical distance between the totalrevenue and total cost curves. In economics, normal profit is considered part of firm’s costsStudy Session 4, Reading 15
  35. 35. Profit Maximizing OutputStudy Session 4, Reading 15
  36. 36. Short Run Profit Maximization In the short run, Profit Maximization occurs when MR = MC. Firm will earn economic profit when TR>TC. Regardless of the time frame, the firm’s motive is always tomaximize profit:Study Session 4, Reading 15
  37. 37. Long Run Profit Maximization Economies of scale benefits occur in the long run. In the long run, the firm will operate at the minimum efficientscale of the long run average total cost curveStudy Session 4, Reading 15
  38. 38. Long Run Profit Maximization Lower prices may occur in the long run due to perfect competitionand greater market supply. In a perfectly competitive market, price equals marginal revenue.Study Session 4, Reading 15
  39. 39. Decreasing Cost Industry A decreasing cost industry occurs due to a reduction inresources cost. As a result, firms are able to charge a lower price.Study Session 4, Reading 15
  40. 40. Increasing Cost of Industry An increasing cost industry results in higher prices and costs inthe long run. An increasing cost industry results in an expansion by currentparticipants of market. An increasing cost industry leads to new entrants in themarket.Study Session 4, Reading 15
  41. 41. Constant Industry Cost No change in the prices or costs of resources. The long run supply curve is horizontal. Prices remain constant in the long run.Study Session 4, Reading 15
  42. 42. Total Product of Labour Total Product of Labour is the sum of production of the firmduring a specific period of time. It is a good measure for gauging the productivity and efficiencyof the firm. It provides an insight into the firm production volume relativeto the industry. Efficiency in producing output is not measured by the totalproduct of labour.Study Session 4, Reading 15
  43. 43. Marginal Product of Labour The Marginal Product of Labour is the productivity of eachunit. It is the difference in total product as a result of using anadditional unit of labour. It is calculated as:orStudy Session 4, Reading 15
  44. 44. Average Product of Labour The Average Product of Labour measures the productivity ofinputs. It is an overall measure of labour productivity. It is calculated as the total product divided by the quantity ofinput:orStudy Session 4, Reading 15
  45. 45. Diminishing Margin Returns Diminishing marginal returns is the decreasing productivity asmore units are added. It occurs when at least one resource is fixed in the short run. Fixed resources restrict the output potential of the worker. The quality of labour constraints can also be a driver ofdiminishing marginal returns.Study Session 4, Reading 15
  46. 46. Diminishing Margin ReturnsStudy Session 4, Reading 15
  47. 47. Market Structures Perfect Competition Monopolistic Competition Oligopoly Pure MonopolyStudy Session 4, Reading 16
  48. 48. Perfect Competition Demand shares an inverse relationship with price . Demand increases as price falls due to the income andsubstitution effect. Output is produced at a level where MR=MC. Marginal Revenue is the increase in total revenue as a result ofone more unit sold. Marginal Cost is the increase in total cost for a one unitincrease in input.Study Session 4, Reading 16
  49. 49. Perfect CompetitionStudy Session 4, Reading 16
  50. 50. Economic Profit and the Elasticityof Demand – Perfect Competition In the short run, a firm can make an economic profit, loss, orbreakeven. In the long run equilibrium, economic profit is zero. The elasticity of demand is higher.Study Session 4, Reading 16
  51. 51. Monopolistic Competition Downward sloping demand curve. Firms produce at the profit maximizing level of output. In the short run, the level of output occurs where MR=MC.Study Session 4, Reading 16
  52. 52. Economic Profit and the Elasticityof Demand – MonopolisticCompetition Firms earn zero economic profit and excess capacity exists inthe long run due to entry and exit. Demand is less elastic due to brand loyalty and productdifferentiation.Study Session 4, Reading 16
  53. 53. Oligopoly Firms face a kinked demand curve. Pricing interdependence exists between firms. Output levels are produced where MR=MC.Study Session 4, Reading 16
  54. 54. Economic Profit and the Elasticityof Demand – Oligopoly Firms can make economic profits in the long run. Demand elasticity is high.Study Session 4, Reading 16
  55. 55. Monopoly Demand curve is negatively sloped. Income and substitution effect.Study Session 4, Reading 16
  56. 56. Economic Profit and the Elasticityof Demand – Monopoly Economic profit is earned by a monopoly producer is calledmonopoly profit. A monopolist tries to provide a good which has no substitutes,which results in inelastic demand.Study Session 4, Reading 16
  57. 57. Supply Function of Firms in PerfectCompetition The supply curve has a positive slope, whereby firms producemore as prices increase. The sum of the individual firm supply curves results in themarket supply curve.Study Session 4, Reading 16
  58. 58. Supply Function of Firms inMonopolistic Competition The intersection of MR and MC determines the optimal levelof output. The supply curve shows the level of quantity a firm is willing toprovide at different prices.Study Session 4, Reading 16
  59. 59. Supply Function of Firms inOligopoly Firms in an oligopoly will only produce the profit maximizingquantity which are MR=MC. Price change is determined by the demand function.Study Session 4, Reading 16
  60. 60. Supply Function of Firms inMonopoly Supply based on the firm’s cost structure. No well-defined supply function. Profit maximizing output is MR=MC. No supply curve for monopolists.Study Session 4, Reading 16
  61. 61. Profit Maximizing Output and Pricefor Firm in Perfect Competition Horizontal demand curve for firms. Downward sloping demand curve for the market. The horizontal line is also the average revenue and marginalrevenue schedule of the firm.Study Session 4, Reading 16
  62. 62. Profit Maximizing Output and Pricefor a Firm in MonopolisticCompetition Profit maximized at MR = MC Economic profit = TR – TC Firm will not produce where MR<MCStudy Session 4, Reading 16
  63. 63. Profit Maximizing Output and Pricefor a Firm in an Oligopoly No single optimum price or output level. Interdependence for pricing makes it very difficult to have oneoptimum price. For a kinked demand curve, the price is at the spot of the kinkin the demand curve. In the case of one dominant firm, the profit maximizationpoint occurs where MR=MC .Study Session 4, Reading 16
  64. 64. Profit Maximizing Output and thePrice for a Firm in an Monopoly The profit maximizing output level occurs in the elastic part ofthe demand curve. MR will always intersect MC where MR is positive. Demand is considered elastics when the quantitydemanded responds more than the price change.Study Session 4, Reading 16
  65. 65. Effects of Demand Changes, Entryand Exit of Firms, and Other Factorson Long-Run EquilibriumPerfect Competition Economic profits make the market more attractive to newentrants. As a result, output increases as new players enter the industry. Aggregate supply increases and shifts the supply curve to theright. This results in lower equilibrium price for a specific level ofdemand. Perfectly competitive firm operates at the level of outputwhere MR=AC, where entry is no longer profitable.Study Session 4, Reading 16
  66. 66. Effects of Demand Changes, Entryand Exit of Firms, and Other Factorson Long-Run EquilibriumPerfect CompetitionStudy Session 4, Reading 16
  67. 67. Effects of Demand Changes, Entryand Exit of Firms, and Other Factorson Long-Run EquilibriumMonopolistic Competition Economic profit will attract new firms to the industry. Customers will be divided between a higher number ofproducers. Demand for every firm will decrease. In the long run, economic profit will be zero.Study Session 4, Reading 16
  68. 68. Effects of Demand Changes, Entryand Exit of Firms, and Other Factorson Long-Run EquilibriumMonopolistic CompetitionStudy Session 4, Reading 16
  69. 69. Effects of Demand Changes, Entryand Exit of Firms, and Other Factorson Long-Run EquilibriumOligopoly Economic profit is possible in the long run. The market share of a dominant firm decreases. Due to increasingly efficient production techniques, new firmshave lower costs. Demand and MR for a dominant firm decreases.Study Session 4, Reading 16
  70. 70. Effects of Demand Changes, Entryand Exit of Firms, and Other Factorson Long-Run EquilibriumMonopoly Unregulated monopolies can earn economic profit in the longrun. All of the factors of production are variable in the long run. Some factors of production are fixed in the short run. Monopolies are protected by barriers to entry.Study Session 4, Reading 16
  71. 71. Concentration Ratio The Concentration Ratio is the sum of market shares of thelargest firms in the market. The Concentration Ratio is bounded between 0 and 100%. It is simple to compute. The Concentration Ratio does not directly measure marketpower. The Concentration Ratio is unaffected by mergers between theparticipants of the market.Study Session 4, Reading 16
  72. 72. Herfindahl-Hirschman Index The Herfindahl Hirschman Index (HHI) measures the marketshares of the top companies squared and then summed. HHI is 1 if one firm controls the market (monopoly). If more than one firms operates in the market, then theHHI=1/M (where M is number of firms). The entry of a new firm and the elasticity of demand areignored.Study Session 4, Reading 16
  73. 73. Identifying the Type of MarketStructure Markets where firms have pricing power can be inefficient ifunregulated. This occurs because producers have an incentive restrictoutput. Prices tend to rise in industries where products have a highmarket value. Excessive market concentration is hard to measure and define. In the instance of an imminent merger, analysts shouldconsider the impact of competition lawStudy Session 4, Reading 16