# Micro Econ Exam 2

 blank blank (the assumption which mainstream micro relies upon that people are motivated first of all by concern to improve their own welfare and that of their family) self-interest motivation (the idea that people act predictably on the basis of stable preferences, and usually know their own preferences clearly) rationality (the influential new school within microeconomics which conceives decision-makers as neither consistently rational nor reliably described as always motivated by self-interest. Our textbook doesn't talk about this newer development) behavioral economics (the satisfaction, or want-satisfying power, a consumer expects to get from consuming a product) utility (the added satisfaction a consumer gets from consuming ONE added unit of a product, like one slice of pizza) marginal utility (the [hypothetical] units in which utility is measured; a unit of satisfaction) util (the total satisfaction a consumer gets from ALL the units of a certain product consumed within a certain time period) total utility (the principle that the marginal utility of a product decreases as more and more units of the product are consumed in a given time period; the 4th pizza slice doesn't please you as much as the 1st) the law of diminishing marginal utility (how much satisfaction PER DOLLAR a product offers a consumer; sort of a "bang per buck" measure, obtainable by dividing the Marginal Utility of the last unit of the item consumed by its Price).If the marginal utility of the last unit of X bought is 8 utils, for example, and the price is \$2, the marginal utility per dollar is 8utils/\$2 = 4 utils per dollar. Marginal Utility per dollar (MU/P) (when the consumer has spent her/his money just so as to maximize the utility they can get from their budget; to reach this state the rule is that the marginal utility per dollar of the last dollar spent on each good must be the same: for goods X, Y, and so on,MUx/Px = MUy/Py = ...MUz/Pz...) consumer equilibrium (total revenue - total cost in a time period) profit (economic costs of production include both explicit costs and implicit costs) total economic costs of production (actual payments a firm must make in order to hire the inputs it needs to carry out its production in a period) explicit costs (or accounting costs) (opportunity costs the owner(s) of a firm incur by investing their own resources -- labor, savings, buildings, etc. -- in the firm) implicit costs (a time period short enough that at least one input into the firm's production [generally the building, or 'plant'] is fixed; it cannot be increased as output increases) the short run (a time period long enough that all inputs are variable -- firms have enough time to build larger factories, new factories, and whatever else they need to increase production) the long run (inputs which a firm can vary even in the short run if it wishes to increase output . Generally thought of as labor and materials inputs). variable inputs (inputs which firms are unable to vary in the short run. Fixed inputs do not vary as output levels vary. Example: the "plant" or building the firm operates in, or the interest payments the firm owes on a loan.) fixed inputs (total costs of fixed inputs during a time period) (Total) Fixed Costs (FC) (Total) Variable Costs (VC) (total costs of variable inputs during a time period (total costs = fixed costs + variable costs). Remember also that all economic costs -- explicit and implicit -- are included in these variables Total Costs (TC) (total revenue - total economic costs) economic profit (means the firm has made a NORMAL rate of return on its owners' invested resources -- enough to pay the owners for their opportunity costs--but no more than that.Zero economic profit means in effect that the firm DID OK) zero economic profit (total revenue - accounting costs) Accounting profit is larger than economic profit, since implicit costs are not subtracted from accounting profit.) accounting profit (the added output produced when one more unit of labor is added to a firm, all else constant) marginal product of labor (a function or listing showing how output levels [Q] vary as variable inputs vary, all else constant) production function (the principle that as a firm adds more and more of a variable input [like labor] to a fixed input [like the plant, or building], after a certain point it gets less and less ADDED output from each added unit of variable input;OR: ... after a certain point the marginal product of labor decreases.) law of diminishing marginal returns (the ADDED total cost a firm has to pay when it increases its output (Q) by ONE UNIT;If for example Total Costs change from \$2,000 to \$2010 when output (Q) rises from 100 to 101, the marginal cost of the 101st unit is \$10.) marginal cost (Fixed costs per unit at a certain output level.AFC = FC/Q.If for example FC in a time period are \$800 and Q = 100, AFC = \$8.) Average Fixed Cost (AFC) (Variable Costs per unit at a certain output level.AVC = VC/Q.If for example VC in a time period are \$1200 and Q = 100, AVC = \$12.) Average Variable Cost (AVC) (Total Costs per unit at a certain output level.ATC = TC/Q.If for example TC in a time period are \$2,000 and Q = 100, ATC = \$20.) Average Total Cost (ATC) (know how generic or average short-run cost curves work:AVC fall then rise as Q increases (as you move to the right on the graph)ATC lies above AVC, since it also includes AFC (ATC=AVC+ AFC). Like AVC, ATC falls for a period then rises as Q increases.The Marginal Cost [MC] curve starts below the average cost curves and eventually rises to cut both AVC and ATC at each one's minimum point and thereafter lie above the AVC and ATC curvesIf you are confused, see Exhibit 4 on page 153 in the book, or lecture 9 in the course WebCT lectures) short-run cost curves for an average firm (If at a certain level of outputMC is above ATC, then average total costs are rising as Q increases [the ATC curve slopes up]MC is below ATC,. then average total costs are falling as Q increases [the ATC curve slopes down]MC equals ATC, then average total costs are constant [the ATC curve is flat] the marginal-average rule (Long Run Average Cost curves show how a firm's Average Total Costs would vary as the firm got larger and larger (so that on the graph you moved further and further to the right on the graph) Long Run Average Cost (LRAC) Curves Where does the LRAC curve come from? (Long run average cost [LRAC] curves show all the lowest possible cost points from various short-run ATC curves as the firm gets larger and larger) (LRAC curves are ordinarily thought to be U-shaped -- long run average costs fall as output increases, then stay constant, then begin to rise) Shape of Long Run Average Cost Curves (The left-most portion of the LRAC curve, where average costs of product fall as output increases [the LRAC curve is negatively sloped]; in this range of output, costs fall as the firm gets larger.Possible reasons: firms can use more efficient [larger] machines as firm size grows, as well as division of labor, and mass production-style production processes.) Economies of Scale (region of the LRAC curve) (the middle region of the LRAC curve, where costs stay the same as output levels [and firm size] increase) Constant Returns to Scale (region of the LRAC curve) (the right-most region of an LRAC curve, where as output levels [and firm size] increase, average costs start to rise.LRAC curve slopes up.Possible reasons: too many layers of management make production less efficient as the firm gets too large.) Diseconomies of Scale (region of the LRAC curve) ( markets in which many small firms produce the product the product is homogeneous entry into and exit from the industry are easy [no big barriers], and information [about the product, etc.] is readily available to both buyers and sellers) perfectly competitive markets (output which is identical in the eyes of buyers regardless of which firm makes it -- like grade A wheat) homogeneous output (firms in perfectly competitive industries are price takers --they cannot control the price they charge; they can only sell their product at the market priceexisting at the moment) the price charged by perfectly competitive firms (perfect competitors face a perfectly elastic [totally flat] firm demand curve -- that is, they can only charge one price -- the market price for their product) perfectly competitive firm's firm demand curve (the market demand curve in perfectly competitive markets, like other markets, slopes down) market demand curve for perfectly competitive markets (the added revenue a firm gets from selling one more unit of its product) marginal revenue (for perfectly competitive firms, marginal revenue = price) marginal revenue for a perfectly competitive firm (increase output untilprice = marginal cost;or, more accurately, until marginal cost is driven up just equal to the market price level--that's the profit-maximizing output level.) profit-maximizing output level for aperfectly competitive firm (increase output until marginal revenue = marginal cost) profit-maximizing output level for any firm (profit per unit is the difference between Price and Average Total Cost at the profit-maximizing output level;if Price is \$10 and average total costs are \$8, for example, profit per unit is \$2.total profit is profit per unit times the profit-maximizing output level [or quantity produced]If profit per unit is \$2 and quantity produced is 200, total profit is \$400.) Analyzing profit per unit and total profit for a competitive firm In the short run in perfectly competitive markets, a firm may make negative, zero, or positive economic profits.Market prices get pushed up or down by changing market conditions in the short run.If market price falls below the firm's minimum Average Total Cost, the firm runs a loss.If market price rises above the firm's Average Total Cost at the profit-maximizing output level, the firm runs a profit,If market price equals Average Total Cost at the firm's profit-maximizing output level, the firm earns zero profit. Perfect competitors'short-run profit levels (shut down only if price falls below the minimum point on the average VARIABLE cost curve;if market price stays above that point, even if it is below the firm's average TOTAL costs, the firm is better off staying in business. It will run a loss, but it will be a smaller loss than it would suffer if it shut down altogether.) Competitive firms'shut-down point in the short run (in the long run, perfectly competitive firms earn zero economic profitthat is because if in an initial situation there IS positive profit, new firms will enter the industry [since entry is by definition easy in these industries, and new firms are always attracted by positive profit--and in the long run there's enough time to enter]. When they enter, they increase market supply and that pushes the market price down. Firms will keep entering until market price is pushed all the way down to the point that it just equals Average Total Cost at the firm's profit-maximizing output level: that means zero economic profit.) Perfect competitors'long-run profit levels (the firm's short-run supply curve isits marginal cost curve, or at leastthe portion of the marginal cost curve above the minimum average variable costa firm's short-run supply curve shows -- as you may remember--the quantities it would like to produce and sell at each possible price, all else constant.Given a certain price, firms wish to raise output right to the point that the price line crosses the marginal cost line; that makes the marginal cost curve (above a certain point) the same as the firm's supply curve. Firm's short-run supply curve As more Big Macs are consumed each day, the marginal utility that a person gets from each additional Big Mac tends to : A. remain constant    B. decrease C. rise at a steady rate   D. accelerate decrease : this is an example of the law of diminishing marginal  utility Suppose a consumer wants to obtain the highest possible satisfaction from goods purchased on a fixed budget. Which of the following must be equal for all goods?    A. Marginal utility per dollar Marginal utility per dollar  B. Total utility    C. Marginal utility    D. Average utility Marginal utility per dollar -- the satisfaction per buck spent -- for the last dollar spent on each item is equal once the consumer has reached the best possible consumption decision. Marginal utility per dollar can be found by calculating MU/P for the last unit of each good bought. The change in total satisfaction that a consumer experiences from consuming one more unit of a good is called:  B. Marginal Utility Suppose the law of diminishing marginal utility holds for coffee. As a person drinks more coffee during the day, the TOTAL utility she or he receives from coffee tends to    A. rise, but at slower and slower rates According to the law of diminishing marginal utility, marginal utility tends to decline as: B. more of a good is consumed Which of the following must happen in order to have consumer equilibrium?    A.  The consumer's total utility must be at a maximum. : This is true more or less by definition. The consumer is not in equilibrium unless they have "maximized" their total utility -- spent their money in the most pleasing way possible for themselves. Consider a consumer who spends all income on only two goods: pizza and soda. An extra slice of pizza would give the consumer 60 extra utils, while an extra can of soda would give the consumer 20 extra utils. Pizza costs \$3 per slice, and soda costs \$1 per can. In this situation, the consumer  D.  has maximized his or her utility : Since the marginal utility per dollar of the last dollar spent is the SAME for both goods (MU/P = 20 utils per dollar), the consumer has maximized her utility. Consider a consumer who spends all income on only two goods: bread and wine. An extra loaf of bread would give the consumer 10 extra utils, while an extra bottle of wine would give the consumer 60 extra utils. Bread costs 50 cents per loar, and wine costs \$6 per bottle. In this situation,  A.  could increase utility by buying more bread and less wine : Since the marginal utility per dollar for bread is 20 (MU/P = 10utils/\$.50 = 20 utils per \$) while the marginal utility per dollar for wine is 10 (MU/P = 60 utils/\$6 = 10 utils per \$), the consumer would be better off (enjoy higher total utility) by buying less wine and using the money to buy more bread The consumer equilibrium condition for two goods is achieved by equating the: D.  ratios of marginal utility to price for the last dollar spent on each good. During the course of a week McDonald's has enough time to hire or layoff workers, but it does not have enough time to expand its kitchen or add an additional seating area. In this situation, McDonald's: D. operates in the short run : the short run is a period of time during which at least some inputs are fixed and cannot be varied--in this case (and in most cases) the building, or "plant" within which the firm operates. Economists say that a firm has a normal profit when    C. economic profit is zero : "zero" economic profit means the firm earned a normal rate of return on its investment but no more than that. A production function shows D.  total output which can be produced at various levels of variable input in the short run Economic profit equals accounting profit minus  A.  implicit costs : Economic profit only occurs if a firm earns revenues above and beyond not only its explicit costs (payroll, taxes, etc.) but also above and beyond its implicit costs (the opportunity costs of the owner's invested resources). To get economic profit from accounting profit (which pays no attention to implicit costs), the implicit costs have to be subtracted. Economic profit is SMALLER than accounting profit, since it has more subtracted out of it. When a firm increases its output in the short run, its marginal cost tends to rise because of A.  diminishing marginal returns : As firms raise output in the short run, they add more variable inputs to at least one fixed input (like the plant), and after a certain point they get less and less added output from each added unit of variable input (for example each added worker); that is the law of diminishing marginal returns During the short run, a firm has enough time to adjust  D.  its variable inputs : variable inputs are those inputs (like labor and materials supplies) which CAN be adjusted even in the short run Which of the following is the best example of a fixed cost?  C.  cost of insurance : Firms have to pay insurance no matter how much output they produce during a period -- so insurance is an overhead, or "fixed," cost. If a firm is earning economic losses  A. the owner could be earning more in some other occupation : an economic loss means that the firm is not earning enough revenue to cover all of its costs, including the opportunity costs associated with the resources the owner invested in the business (including labor, buildings, funds,...). Hence to run a loss means you could be doing better with your resources (including your labor) elsewhere. The output added by an additional unit of labor input (say, an added worker hired) is called  B. the marginal product of labor If a firm's use of labor obeys the law of diminishing marginal returns, then  C.  hiring additional workers adds less and less additional output : (see the explanation for answer c in question 7 above) If at a certain output level, a firm's marginal costs are BELOW its average total costs, then we know for sure that: B. the firm's average total costs are falling (as output increases) at that output level : when MC is less than ATC, ATC is falling; when MC equals ATC, ATC is constant; when MC is greater than ATC, ATC is rising. As a firm attempts to increase its production, its LONG-RUN average costs eventually rise because of D.  diseconomies of scale : this is the name for what is supposed to happen to firms when they get too large to be ideally efficient in the long run (as firm size, including plant and capital, managerial layers, etc. increases). The primary cause if diseconomies of scale is probably:  A.  communication and management problems within a very large firm : the usual argument is that there come to be too many managerial layers to make decision-making and cost-control work very well Economies of scale are created as firms expand in the long run and find greater efficiencies of capital as well as B.  increased specialization of labor : Increased specialization of labor is commonly cited (ever since Adam Smith, 1776)as one of the reasons why average total costs might fall as firms become larger, for this range of the Long Run Average Total Cost curve. Consider the following pizzeria. When the firm produces zero pizzas per hour its total variable cost (TVC) is \$0 and its Total Cost (TC) is \$20. When it produces 10 pizzas per hour its TVC is \$50 and TC is \$70. When it produces 20 pizzas per hour its TVC is \$80 and its TC is \$100. When it produces 30 pizzas per hour its TVC is \$130 and its TC is \$150. When it produces 40 pizzas per hour its TVC is \$230 and its TC is \$250. This restaurant's average variable costs (AVC) when they produce 20 pizzas per hour are  A. \$4 per pizza  B. \$5 per pizza C. \$3 per pizza D. \$2 per pizza \$4 per pizza : At Q = 20 pizzas per hour, Total Variable Costs are \$80. Average Variable Costs are (Total Variable Costs)/Q = \$80/20 = \$4 per pizza. Constant returns to scale cause the long-run average cost (LRAC) curve to be  D.  horizontal : in the region of a long-run average cost curve where constant returns to scale prevail, the LRAC curve is flat (or horizontal) Consider the pizzeria whose costs are described in question 5 above. (Consider the following pizzeria. When the firm produces zero pizzas per hour its total variable cost (TVC) is \$0 and its Total Cost (TC) is \$20. When it produces 10 pizzas per hour its TVC is \$50 and TC is \$70. When it produces 20 pizzas per hour its TVC is \$80 and its TC is \$100. When it produces 30 pizzas per hour its TVC is \$130 and its TC is \$150. When it produces 40 pizzas per hour its TVC is \$230 and its TC is \$250.) The average total cost of producing 40 pizzas per hour is equal to:  A.  \$6.25 per pizza : Average total cost at a particular level of output (Q) can be found by dividing Total Cost (at that output level) by that output level (Q): ATC = TC/Q = \$250/40 = \$6.25 per pizza Consider the pizzeria whose costs are described in Question 5 above. (Consider the following pizzeria. When the firm produces zero pizzas per hour its total variable cost (TVC) is \$0 and its Total Cost (TC) is \$20. When it produces 10 pizzas per hour its TVC is \$50 and TC is \$70. When it produces 20 pizzas per hour its TVC is \$80 and its TC is \$100. When it produces 30 pizzas per hour its TVC is \$130 and its TC is \$150. When it produces 40 pizzas per hour its TVC is \$230 and its TC is \$250. ) What is this restaurant's marginal cost of increasing production from 10 to 20 pizzas? D.  \$3 per pizza : Marginal cost is the ADDED cost of an ADDITIONAL unit of output (in this case, pizza). When the cost variables are presented as they are in question 2, it can be found as: marginal cost = (change in Total Cost)/(change in output). In this case the change in Total Cost is \$30 (since when production rises from 10 to 20 TC rises from \$70 to \$100). The change in output is 10 (from 10 to 20). So marginal cost = \$30/10 = \$3 per pizza. In short run cost theory,  C.  the average total cost curve always lies above the average variable cost curve : Since average total costs INCLUDE average variable costs (and also include average fixed costs) ATC is always above AVC at all output levels. Average variable costs are best described as D.  a firm's labor and materials cost per unit produced : AVC = VC/Q; this calculation gives average variable costs per unit -- or, approximately speaking, labor and materials costs per unit. When a firm produces zero pizzas per hour its total variable cost (TVC) is \$0 and its Total Cost (TC) is \$20. When it produces 10 pizzas per hour its TVC is \$50 and TC is \$70. When it produces 20 pizzas per hour its TVC is \$80 and its TC is \$100. When it produces 30 pizzas per hour its TVC is \$130 and its TC is \$150. When it produces 40 pizzas per hour its TVC is \$230 and its TC is \$250. The pizzeria's total FIXED COST is equal to:  B.  \$20 : The fixed cost can be found from the information above by looking at total cost when output = zero. When output = zero, all costs are fixed costs, since there are no variable costs. The lowest point on the average total cost curve is  C. where it intersects the marginal cost curve Which of the following statements holds true for a perfectly competitive industry?    A.  The firms produce a homogeneous product. : This is part of the definition of perfectly competitive market structure. In a perfectly competitive long-run equilibrium  B. firms earn zero economic profit : since entry is easy, any positive economic profit attracts entry; the long run is a period of time long enough that any firm which wishes to may enter. As firms enter, they shift the market supply curve to the right and lower the market price -- all they way to the point that firms will find their average total costs just equalling price at the profit-maximizing output level -- so that in the long run firms earn zero economic profit (and no more firms will seek to enter the industry). Which of the following is NOT a characteristic of a perfectly competitive market? B.  firms are price makers, not price takers : since perfectly competitive firms can sell any amount of output they wish at the fixed market price existing in their industry, they have no choice but to accept the existing price (be a price taker) if they wish to participate in the industry. A competitive firm maximizes its profits (or minimizes its losses) by producing the quantity where the market price equals the firm's  D.  marginal costs : That's the profit maximizing rule for competitive firms: keep increasing output until Price = Marginal Cost. Then stop. That is the most profitable (or least unprofitable) output the firm can operate at. Firms in perfectly competitive industries maximize their short-run profits by producing at the level of output at which  C.  marginal cost is equal to the market price : The rule for maximizing profit is : Raise output to the exact point at which Marginal Revenue = Marginal Cost. Since for perfect competitors Price is equal to Marginal Revenue, their rule is to raise output to the exact point at which Price = Marginal Cost. A firm should shut down in the short run if  A. the market price is less than its lowest possible average variable cost : This is the rule for short-run shutdown: the firm is better off shutting down immediately, even in the short-run, if and when market Price falls below minimum average VARIABLE cost. Because a perfectly competitive firm is a price taker, it faces a demand curve that is A.  perfectly elastic : perfectly elastic demand is a totally horizontal firm demand curve, which is the firm demand curve faced by "price takers," or perfectly competitive firms For perfectly competitive firms, marginal revenue is  A. simply equal to the market price : In perfectly competitive markets (only), price and marginal revenue are the same. (Remember that marginal revenue is the added total revenue a firm receives when it sells one more unit of its output.) The MARKET (not firm) demand curve for a perfectly competitive industry is  A. downward sloping : MARKET demand curves are ALWAYS downward sloping (given the law of demand). It is only the FIRM demand curve which is perfectly flat, for a perfectly competitive firm. Authornikki002 ID228561 Card SetMicro Econ Exam 2 DescriptionMicro Econ Exam 2 Updated2013-07-31T03:47:33Z Show Answers