Chapter 7

Question 1

How is demand defined?

Answer 1

How much potential consumers are willing to pay for its product

Question 2

How are total costs calculated?

Answer 2

Unit cost * quantity

Question 3

How is total revenue calculated?

Answer 3

Price * quantity

Question 4

How is profit calculated?

Answer 4

Total revenue - total cost

Question 5

How would you find the profit maximising point on isoprofit graph?

Answer 5

Where the slope of the isoprofit curve equals the slope of the demand curve

MRS=MRT

Question 6

What is the feasible set on an isoprofit graph?

Answer 6

All area bellow the demand curve

Question 7

What do a firms costs depend on?

Answer 7

It’s scale of production and they type of production technology it has

Question 8

If input increases by a given proportion, and production increases more than proportionally then …

Answer 8

The technology exhibits increasing returns to scale in production
Economies of scale

Question 9

If input and production increase proportionally then…

Answer 9

Technology exhibits constant returns to scale in production

Question 10

If input increases and production increase less than proportionally then…

Answer 10

Technology exhibits decreasing returns to scale in production
Diseconomies of scale

Question 11

What are cost advantages in economies of scale?

Answer 11

Large firms can purchase inputs on more favourable terms as they have greater bartering power when negotiating with suppliers

Question 12

Some demand advantages in economies of scale are …

Answer 12

Network effects (value of output rises with number of users eg software applications)

Question 13

What does the cost function show?

Answer 13

Shows how total production costs vary with quantity produced

Question 14

How is average cost calculated?

Answer 14

Average cost is the cost per unit produced

Is the slope of the ray from the origin to a given point on the cost function

Question 15

What is marginal cost?

Answer 15

The effect on the total cost of producing one additional unit of output
Calculated as the slope of the cost function at a given point

Question 16

What statements are always true about the relationship between AC and MC?

Answer 16

AC> MC then AC is decreasing

AC

Question 17

What does the demand curve represent?

Answer 17

The quantity that consumers will buy at each price

Question 18

What do the isoprofit curves show?

Answer 18

The price-quantity combinations that give the same profit

Question 19

What is constrained optimisation?

Answer 19

The objective of a firm is to optimise something (utility, costs, profit) but the decision maker faces a constraint which limits what is feasible (budget constraint, demand curve, feasible set)

Question 20

What is marginal revenue?

Answer 20

Change in revenue from selling an additional unit (net effect of decreasing price and increasing quantity sold)

Question 21

At what point will a firm be choosing the profit maximising choice?

Answer 21

Where MR=MC

Question 22

What should a firm do if MR> MC?

Answer 22

The firm should raise Q (quantity) as profits would increase

Question 23

If the marginal profit is negative what should a firm do?

Answer 23

MR

Question 24

What is consumer surplus?

Answer 24

The total difference between willingness to pay and the purchase price

Question 25

What is producer surplus?

Answer 25

Total difference between revenue and marginal cost

Question 26

What is total gains from trade?

Answer 26

Total surplus (consumer surplus + producer surplus)

Question 27

When is a point in the price quantity space said to Pareto efficient?

Answer 27

All trades which would give a positive surplus are realised
No deadweight loss
Total surplus cannot be increased by changing the level of production

Question 28

What is deadweight loss?

Answer 28

A loss of total surplus relative to a Pareto efficient allocation (unexploited gains from trade)
The area between the demand curve and marginal profit that isn’t shaded

Question 29

What is price elasticity of demand?

Answer 29

Measure of responsiveness of consumers to a price change

Question 30

How is price elasticity of demands calculated?

Answer 30

ε=-%change in demand/%change in price

Question 31

When demand is elastic what value should MR have?

Answer 31

Greater than one

Question 32

If the demand curve is quite flat what would that mean for elasticity and why?

Answer 32

High elasticity because the quantity changes a lot in response to price changes

Question 33

What does high elasticity mean?

Answer 33

That price will only fall a little if the firm increases its quantity
Products that would have a high elasticity include heinz soup, dairy milk
There are many alternatives so a change in price will cause a lot of people to jump brands

Question 34

What types of products would be inelastic?

Answer 34

Petrol, salt, diamonds

Products that there are few alternatives for

Question 35

How would a firm increase profit margins if the product had low elasticity?

Answer 35

They can raise price above marginal cost as there are few alternatives so people will still purchase the product

Question 36

How can governments raise more tax revenue in terms of elastic or inelastic goods?

Answer 36

Levying taxes in price inelastic goods

Question 37

Why is competition policy good for consumers?

Answer 37

It limits firms market power and helps stop firms colluding to keep prices high

Question 38

What is a natural monopoly?

Answer 38

When one firm can produce at a lower cost than two or more firms

Question 39

Why is monopoly rent an example of market failure?

Answer 39

As there is deadweight loss due to firms setting prices above marginal cost

Question 40

How can firms increase their market power?

Answer 40

Innovating - allows them to differentiate products from competitors, can invent entirely new products and stop competition through patents or copyright laws

Advertising - attract mire customers away from competitors