Econ Exam 1

Question 1

Economic Assumptions of Perfectly Competitive Market

Answer 1

1) firms are price takers (large #, sell identical products, full info on both sides, low transaction costs, firms can freely enter/exit market)
2) cannot sell above market price
3) perfect mobility of production factors
4) no externalities

Question 2

Production Function

Answer 2

q= f (L, K), usually K is fixed in the short run, lariable labor

Question 3

Marginal Product of Labor

Answer 3

MPL= dq/dL = d [f (K,L)]/ dL “additional output produced by an additional unit of labor”

Question 4

Average Product of Labor

Answer 4

APL = q/L “ratio of output to unit of labor”

Question 5

Relationship between APL and MPL

Answer 5

APL max. when APL= MPL, both rise at first, but when MPL crosses over APL, they both fall, a firm will only operate if MPL is positive

Question 6

Law of Diminishing Marginal Returns

Answer 6

holding all other inputs + tech constant an increase in input will lead to diminishing increase in output

Question 7

Long Run

Answer 7

K and L variable

Question 8

Isoquant

Answer 8

curve of efficient combinations of inputs for fixed amount of q (cardinal not just ordinal)

Question 9

Properties of Isoquant

Answer 9

• farther from origin= greater level of output
• cannot cross
• downward slope
• thin

Question 10

Reinstatement Effect

Answer 10

technology requires new kinds of labor but labor still has comparative advantage (e.g. cyber security jobs)

Question 11

Perfect Substitutability Isoquants

Answer 11

Isoquants that are straight line (demand direction)

Question 12

Fixed Proportions Isoquants

Answer 12

Right angle isoquants (e.g. Leontief, workers and lawnmowers

Question 13

Marginal Rate of Technical Substitution (MRTS)

Answer 13

“how many unites of K the firm can replace with extra unit of L”, MRTS= change in K/ change in L

MRTS= dK/dL = -MPL/MPK

instantaneous slope of isoquant line

Basically the MRS but the two goods are L and K

Question 14

Why does MRTS diminish along convex isoquant?

Answer 14

the more L a firm employs the fewer K would be needed to replace, if firm employs very little L, you would need a lot of K to replace one unit of L

Question 15

What measures the curve of the isoquant?

Answer 15

Elasticity of Substitution (K and L)

d(K/L)/dMRTS [MRTS/(K/L)]

Question 16

Types of Elasticity of Substitution (K and L)

Answer 16

omega = 1/1-price

Linear: omega = infinity
Leontief: omega approaches 0
Cobb Douglass: omega = 1

Question 17

Constant Returns to Scale

Answer 17

x% increase in input yields x% increase in output

Test: f(2L + 2K) = 2 f(L, K)

Question 18

Increasing Returns to Scale

Answer 18

increase input yields greater increase in output
Test: f(2L + 2K) greater than 2 f(L, K)
Usually happens with specialization

Question 19

Decreasing Returns to Scale

Answer 19

increase input yields less increase in output
Test: f(2L + 2K) less than 2 f(L,K)
Usually happens when organizing/coordinating production is difficult

Question 20

Explicit Cost

Answer 20

direct out-of-pocket (part of opportunity cost)

Question 21

Implicit Cost

Answer 21

reflect a foregone opportunity (part of opportunity cost)

Question 22

Opportunity Cost

Answer 22

Value of “best alternative”
Total opportunity cost = explicit + implicit
*do not include sunk cost

Question 23

Opportunity cost of capital

Answer 23

unclear, if rented it =rent

If $ could have been invested elsewhere, then it’s market rate return on investment

Question 24

Short Run Total Cost Function

Answer 24

Total Cost = Vc (q) + F

Question 25

Sunk Cost

Answer 25

not included in opportunity cost *need more details

Question 26

Marginal Cost (MC)

Answer 26

Mc = dC(q)/dq *derivative of cost function wrt q "additional cost as firm produces 1 more unit of output"

Question 27

Average Fixed Cost (AFC)

Answer 27

F/q

Question 28

Average Variable Cost (AVC)

Answer 28

VC/Q C/q = AVC + AFC

Question 29

Average Cost

Answer 29

AC = AVC + AFC | = cost/q

Question 30

Relationship between Marginal and average costs in short run

Answer 30

MC = W (1/MPL) since labor is fungible in short run, MC and MPL are inversely related

Question 31

Long Run Costs

Answer 31

everything is variable in the long run

Question 32

Isocost

Answer 32

Combination of inputs yielding same total cost C= WL + rK or K = C/r -(w/r)L

Question 33

Cost Minimizing

Answer 33

(MPL/W) = (MPK/R) bang for buck for labor and capital are equivalent

Question 34

Economies of Scale

Answer 34

LRAC decreases as Q increases (from increasing returns to scale, can be from learning by doing)

Question 35

No Economies of Scale

Answer 35

No change/ constant LRAC as Q increases

Question 36

Diseconomies of Scale

Answer 36

LRAC increases as Q increases (usually result of decreasing returns to scale)

Question 37

Economies of Scope

Answer 37

Cheaper to produce joint goods than seperately

Question 38

How can you tell if something is in economy of scope?

Answer 38

SC= [C(Q1, 0) + C(0, Q2) - C (Q1, Q2)}/[C(Q1, Q2) If SC greater than 0, join production is cheaper if SC less than 0, join production more expensive

Question 39

What is the shape of the Production Possibilities Frontier for an economy of scope?

Answer 39

Bowed away from origin

Question 40

Profit Maximization Assumptions

Answer 40

- Firms are price takers - both buyers and sellers have info about prices - transaction costs negligible - firms freely enter/exit market (but cannot sell above market price) - firms face horizontal demand curve @ market price

Question 41

Profit Function

Answer 41

Profit = Rev (q) - C (q)

Question 42

Profit Maximization (solve for q)

Answer 42

Profit = Rev (q) - C (q) To find profit max, take derivative of profit wrt q, set equal to 0, solve for q Max is when MR(q)= MC(q) In perfect competition MR=P

Question 43

Short Run Shut-Down Decision

Answer 43

Shut down if revenue is less than variable cost pq < VC "if market price is less than min. of short run average variable cost" ignore sunk cost- variable cost is the only that matters in shut down decision in short run

Question 44

Long Run Shut Down decision

Answer 44

if expected profits < 0 | shut down point = minimum of LRAC curve

Question 45

Long Run Market Supply

Answer 45

Assuming identical firms, free entry, and constant input price LR market supply is horizontal at min. LRAC *LR market supply will not be flat if 1) entry limited, 2) firms differ, 3) input prices vary w/ output

Question 46

Theory of Second Best

Answer 46

if an economy has two (or more) distortions alleviating only one may not improve welfare

Question 47

Producer Surplus

Answer 47

Amount above supply below price "amount above marginal cost that suppliers would have supplied at but didn't have to"

Question 48

Deadweight Loss

Answer 48

foregone economic activity brought about by a market distortion; net loss to economic welfare

Question 49

Price Support- Deficiency Payment

Answer 49

Government sets P and pays (p-market clearing price), | "gov pays difference between guarantee and market price"