# Microeconomics Final

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What are the three conditions for a market to be perfectly competitive?
1. There must be many buyers and many firms, all of which are small relative to the market. 2. The products sold by all firms in the market must be identical. 3. There must be no barriers to new firms entering the market.
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What is a price taker?
A price taker is a buyer or seller that is unable to affect the market price.
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When are firms likely to be price takers?
Because a firm in a perfectly competitive market is very small relative to the market, and because it is selling exactly the same product as every other firm, it can sell as much as it wants without having to lower its price. If the firm raises its price, the firm will sell nothing. *(it sells the same thing as every other market)*
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Explain why it is true that for a firm in a perfectly competitive market, P=MR=AR.
A firm in a perfectly competitive market is a price taker and can sell as many units as it wishes at the market price P. By selling an additional unit, the firm receives additional (or marginal) revenue of P. Because each unit is sold at P, the average revenue will also equal P, and we get the result P = MR = AR.
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Explain why it is true that for a firm in a perfectly competitive market, the profit-maximizing condition MR=MC is equivalent to the condition P=MC.
In a perfectly competitive market, MR = P, making these two conditions equivalent.
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What is the relationship between a perfectly competitive firm's marginal curve and its supply curve?
The perfectly competitive firm's supply curve can be directly derived from its marginal cost curve. The firm will produce where P = MC if price is at or above the shutdown point at the minimum of AVC.
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Total Cost (TC)
The cost of all the inputs used by a firm. FC + VC
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Fixed Cost (FC)
Costs that remain constant as a firm's level of output changes
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Variable Costs (VC)
Costs that change as the firm's level of output changes.
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Marginal Cost (MC)
An increase in total cost resulting from producing another unit of output. MC= (change in TC)/(change in output)
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Average Total Cost (ATC)
ATC=TC/Q
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Average Fixed Cost (AFC)
AFC=FC/Q
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Average Variable Cost (AVC)
AVC=VC/Q
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Implicit Cost
a NON-MONETARY opportunity cost ex: wages that an employee could have earned if a vacation was not taken
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Explicit Cost
a cost that involves spending money
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What is the difference between the short run and the long run?
The short run is the period of time during which at least one of a firm's inputs is fixed. The long run is the period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant.
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Is the amount of time that separates the short run from the long run the same for every firm?
The length of time that separates the short run from the long run differs from firm to firm.
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Distinguish between a firm's fixed cost and variable cost and give an example of each.
Fixed cost is a cost that remains constant as output changes. An example would be rent. Variable cost is a cost that changes as output changes. An example would be labor costs.
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average cost of production
the total cost of production divided by the number of units produced.
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marginal cost of production
the change in a firm's total cost from producing one or more unit of a good or service.
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If the marginal product of labor is rising, is the marginal cost of production rising or falling? Briefly explain.
If the marginal production of labor is rising, the marginal cost of production is falling. As long as the additional output from each new worker is rising, the marginal cost of that output is falling.
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As the level of output increases, what happens to the value of average fixed cost?
As the level of output increases, the value of average fixed cost gets smaller and smaller. This happens because in calculating average fixed cost, we are dividing something that gets larger and larger- output- into something that remains constant- fixed cost.
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monopolistic competition
a market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products
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Marginal Cost equals...
Marginal Revenue
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Profit Maximization
MR=MC
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Why doesn't a monopolistically competitive firm produce where P=MC, as a perfectly competitive firm does?
Because P > MR for a monopolistically competitive firm, a profit-maximizing monopolistically competitive firm producing where MR = MC will necessarily produce where P > MC.
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Stephen runs a pet salon. He is currently grooming 125 dogs per week. If instead of grooming 125 dogs, he grooms 126 dogs, he will add \$68.50 to his costs and \$60.00 to his revenues. What will be the effect on his profit of grooming 126 dogs instead of 125 dogs?
If, by grooming another dog, Stephen adds \$68.50 to his costs and only \$60.00 to his revenues, his profit will fall by \$8.50 if he grooms 126 dogs rather than 125 dogs.
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What effect does the entry of new firms have on the economic profits of existing firms?
New firms entering an industry cause the demand curves for the products of existing firms to shift to the left. Existing firms will be able to sell less at every price, so their profits will decline.
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Why does the entry of new firms cause the demand curve of an existing firm in a monopolistically competitive market to shift to the left and to become more elastic?
As more firms enter the industry, the existing firm's demand curve shifts to the left because the firm will sell fewer units of output when there are additional firms in the area selling similar products. And the demand curve becomes more elastic because consumers have additional firms from which to buy their products.
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Why is a monopolistically competitive firm not productively efficient? In what sense does a firm have excess capacity?
A monopolistically competitive firm is not productively efficient because it does not produce at minimum average total cost. Excess capacity stems from the fact that when a monopolistically competitive firm produces where MR = MC, it produces a level of output that is below the quantity for which average total cost is minimized.
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Why is a monopolistically competitive firm not allocatively efficient?
A monopolistically competitive firm is not allocatively efficient because it charges a price that is greater than marginal cost.
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What are the most important differences between perfectly competitive markets and monopolistically competitive markets?
Monopolistic competition is a market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products. A perfectly competitive market is a market that meets the conditions of many buyers and sellers, all firms selling identical products, and no barriers to new firms entering the market.
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Give two examples of products sold in a monopolistic market.
electronics and food.
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Give two examples of products sold in a perfectly competitive market.
fish at a fish market and vegetable and fruit at a farmers market.
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What is an oligopoly? Give three examples of oligopolistic industries in the United States.
Oligopoly is a market structure in which a small number of interdependent firms compete. Examples include cigarettes, beer, aircraft, breakfast cereals, automobiles, and pet food.
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What do barriers to entry have to do with the extent of competition in an industry? What are the most important barriers to entry?
Barriers to entry keep new firms from entering an industry, reducing the extent of competition in the industry. The important barriers to entry are economies of scale, ownership of a key input, and government-imposed barriers.
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Give an example of a government-imposed barrier to entry. Why would a government be willing to erect barriers to entering an industry?
Government-imposed barriers to entry include patents, occupational licenses, barriers to international trade (like tariffs and quotas), and franchises. One reason governments are willing to erect barriers to entering an industry is that these barriers may improve the standard of living in the long run; for example, granting patents encourages the development of new products and technologies. Another reason is that politicians may intentionally reduce competition to aid certain firms in exchange for campaign contributions or other favors from the firms.
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What is a patent? If a patent serves as a barrier to entry, why do governments issue patents?
A patent gives a firm the exclusive right to a product for a period of 20 years from the date the patent is filed with the government. Governments issue patents to encourage firms to carry out research and development, which increases output and living standards in the long run.
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Game theory
the study of how people make decisions in situations in which attaining their goals depends on their interactions with others.
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Cooperative equilibrium
A cooperative equilibrium is one in which players in a game cooperate to increase their mutual payoff.
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Noncooperative equilibrium
A noncooperative equilibrium is one in which players don't cooperate but pursue their own self-interest.
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Dominant strategy
A dominant strategy is one that is best for a player, no matter what strategies other players use.
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Nash equilibrium
A Nash equilibrium is a situation in which each player chooses the best strategy, given the strategies chosen by the other player or players.
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Why do economists refer to the methodology for analyzing oligopolies as game theory?
Because there are so few firms in oligopoly markets, each firm must pay attention to the moves (strategies) of the other firms, just as players do in actual games, such as poker or Monopoly. Game theory is the methodology that examines how to make decisions when attaining one's goals depends on interactions with others, so it is natural to use game theory when studying oligopoly.
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Why do economists refer to the pricing strategies of oligopoly firms as a prisoner's dilemma game?
A prisoners' dilemma is a game in which pursuing dominant strategies results in a noncooperative equilibrium that leaves everyone worse off than they would be if they could achieve the cooperative equilibrium. The outcome of noncooperative pricing (competition, in other words) will leave firms worse off than if they cooperated and set higher prices.
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List the competitive forces in the five competitive forces model.
1) competition from existing firms 2) the threat from potential entrants 3) competition from substitute goods or services 4) the bargaining power of buyers 5) the bargaining power of suppliers
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What is a monopoly? Can a firm be a monopoly if close substitutes for its product exist?
A monopoly is a firm that is the only seller of a good or service that does not have a close substitute. The firm can't have a monopoly if a close substitute for its product exists.
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What are the four most important ways a firm becomes a monopoly?
The most important ways a firm becomes a monopoly are when 1) government blocks the entry of other firms into the market: 2) the firm has control of a key resource: 3) there are important network externalities in supplying the product: and 4) economies of scale are so large that one firm has a natural monopoly.
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If patents reduce competition, why does the federal government grant them?
The government grants patents because it hopes that in the long run society will be better off. The potential profits to be earned by the temporary monopoly will encourage more rapid technological progress and will encourage risk-taking on the part of firms (pharmaceutical companies, for example) that would otherwise not occur. Competition still exists, but it focuses more on coming up with new products and processes.
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What is "natural" about a natural monopoly?
A natural monopoly arises when one firm can supply the entire market at a lower average total cost than can two or more firms. In these cases, the firm doesn't need a special law or strategy to become a monopoly. The monopoly happens naturally.
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What is the relationship between a monopolist's demand curve and the market demand curve? What is the relationship between a monopolist's demand curve and its marginal revenue curve?
The monopolist's demand curve is the market demand curve. The marginal revenue curve is derived from the demand curve. For a linear demand curve, the marginal revenue will be below the demand curve (and it is also twice as steep as the demand curve, because in absolute value, the slope of the marginal revenue curve will be twice the slope of the demand curve).
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Suppose that a perfectly competitive industry becomes a monopoly. Describe the effects of this change on consumer surplus, producer surplus, and deadweight loss.
If a perfectly competitive industry is monopolized, the price will rise and the quantity produced will fall. Consumer surplus will decrease, producer surplus will increase, and there will be a deadweight loss.
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What is the purpose of the antitrust laws? Who is in charge of enforcing these laws?
The avowed purpose of antitrust laws is to eliminate collusion and promote competition among firms. The Department of Justice's Antitrust Division and the Federal Trade Commission enforce these laws.
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What is the difference between a horizontal merger and a vertical merger? Which type of merger is more likely to increase the market power of a newly merged firm?
A horizontal merger is between firms in the same industry, while a vertical merger combines firms at different stages in the production of a good. Horizontal mergers are more likely to increase the market power of the newly merged firm because these mergers reduce the number of firms competing in the market for a particular good or service.
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MR=MC
MR=MC ALWAYS
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Sherman Act
Prohibited "restraint of trade," including price fixing and collusion. Also outlawed monopolization.
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Herfindahl-Hirschman Index (HHI)
created by squaring the percentage market shares of each firm, and adding up the results.
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As a result of the law of diminishing utility, total utility: a) increases at an increasing rate b) never reaches a maximum c) decreases forever d) increases at a decreasing rate
d
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A supply curve shows the relationship between which two variables: a) the price of a good and consumers' income b) the price of a good and the quantity of it supplied c) consumers income and the quantity of a good supplied d) the price of a good and the consumers' income
b
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Total revenue will increase if the price decreases as long as the price elasticity of demand is: a) elastic b) unitary c) inelastic d) zero
a
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Statements about what ought to be are called: a) assumptions b) positive statements c) normative statements d) scientific statements
c
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Normal goods are goods that people buy: a) instead of another product whose price has increased b) less when their income increases c) more of when their incomes increase d) instead of another product whose price has decreased
c
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If a grocery store had a sale on hotdogs, it would be reasonable to expect: a) an increase in the demand curve for hotdogs b) an decrease in the demand curve for mustard c) an increase in the demand curve for hotdog rolls d) all of the above
c
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If there is a shortage of a good, then the quantity demanded ___ the quantity supplied and the price will ___. a) is greater than; rise b) is less than; rise c) is greater than; fall d) is less than; fall
a
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The price of a tomato increases and people buy less lettuce. You accurately infer that lettuce and tomatoes are: a) substitutes b) complements c) normal goods d) inferior goods
b
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Explain the Law of Demand.
The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product increases, and when the price of a product rises, the quantity demanded of the product will decrease.
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Explain the Law of Supply.
The rule that, holding everything else constant, when the price of a product falls, increases in price cause increases in the quantity supplied, and decreases in price causes decreases in the quantity supplied.
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The ability of an individual, a firm, or a country to produce more of a good or service than competitors using the same amount of resources.
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The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.
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opportunity costs
The highest valued alternative that must be given up to engage in activity.
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Which of the following statements is false? a) In the short run: total cost= fixed cost + variable cost b) In the long run there are no fixed costs c) An explicit cost is a non monetary opportunity cost d) Variable costs are costs that change as output changes
C
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Which of the following is NOT an option for a perfectly competitive firm that suffers short-run losses? a) reducing production b) shutting down c) raising prices d) reducing the use of variable factors
C
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If 11 workers can produce a total of 54 unit of a product and a 12th worker has a marginal product of 6 units, then the average product of 12 workers is...
5 units
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Marginal revenue
change in total revenue from selling one or more unit of a product.
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A perfectly competitive firm produces 3,000 units of a good at a total cost of \$36,000. The prevailing market price is \$15. What will happen to the number of firms in the industry and to the industry's output in the long run? a) The number of firms remains constant and the industry's output increases b) The number of firms and the industry's output increases c) The number of firms remains constant and the industry's output decreases d) The number of firms and the industry's output decreases
b
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Which of the following is not true for a firm in perfect competition? a) profit equals total revenue minus total costs b) marginal revenue equals the change in total revenue from selling one more unit c) price equals average revenue d) average revenue is greater than marginal revenue
d
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A prefectively competitive firm has to charge the same price as every other firm in the market. Therefore, the firm: a) is not able to make a profit in the short run b) is a price taker c) sells products that are different than other firms d) faces a perfectly inelastic demand curve
b
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In the ___, all costs are variable. a) short run b) afterlife c) worst case d) long run
d
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If the marginal cost increases, the average cost must: a) increase b) decrease c) stay the same d) approach 0
a
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If total costs are \$200 at an output of zero, the variable costs must be ___ and the average cost ___ at that level. a) \$200, \$0 b) \$200, indeterminate c) \$0, \$0 d) \$0, indeterminate