ECO308 Exam 2 - Custom Scholars
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# ECO308 Exam 2

question
Total Effect
substitution effect + income effect
Price of one good changes relative to another
1)one good becomes more expensive, other is less expensive
question
Substitution effect
change in quantity of a good when that good price changes, holding income and utility constant
buy more of the cheaper good
question
Income effect
change in quantity demanded when theres a change in income, resulting from change in purchasing power
income doesnt actually change but consumer feels richer or poorer depending ∆ in purch power
question
Positive income effect
As a result from gains from trade real incomes rise --> Consumers buy even more.
question
Giffen Goods
goods that are exceptions to the law of demand where at very low prices, with consumers on low incomes and dependent upon the good for survival, as price rises, then so does demand
question
Compensating Variation
the amount of money one would have to give a consumer to offset completely the harm from a price increase
question
Equivalent variation
the amount of money one would have to take from a consumer to harm the consumer by as much as the price increase
question
CV =
Old utility at new prices
question
EV =
new utility at old prices
question
substitution effect
income effect
A -> A"
A" -> B
Should reflect eachother on either side
question
Normality of a good is determined by
Income effect
question
Labor-Leisure Model
...
question
Production Assumptions
- single good
-Capital (K) and Labor (L)
- outputs increase with inputs
-Inputs characterized by diminishing marginal returns
- firm can employ unlimited capital and labor at fixed prices
question
Production Function
Q = f(L,K)
question
Short Run vs Long run production
SR - atleast one factor is fixed
LR - both factors are variable
question
Marginal Product of Labor (MPL) =
(∆q)/(∆L)
- for continuous production function = (dq)/dL)
question
- we expect MPL to be positive but decreasing when capital is fixed
-increase at a decreasing rate
question
Long Run production outputs.. (isoquants)
Can be the same at different variables
- isoquants show combinations of labor that produce the same amount of output
- slope of isoquant shows tradeoffs at any point
question
Slope of the Isoquant =
MRTS
question
MRTS =
-∆K/∆L = (MPL)/(MPK)
describes amount of K needed to keep output constant given 1 unit change in L
question
Isoquant shapes - straight v curved
Straight - imply inputs are relatively substitutable
Curved - imply that inputs are relatively complementary
question
When MRTS is constant
perfect substitutes - traded off inconstant ratio
question
Perfect complements
must be used in a fixed ratio as a part of prod process
question
Returns to scale
change in output when all inputs are increased or decreased in the same proportion
question
Constant returns to scale
double inputs, doubles outputs
question
Increasing returns to scale (decreasing RTS)
changing all inputs by same proportion changes output more than proportionally (less than proportionally)
question
Norms in RTS
CRS is considered normal - still see IRS (learning by doing) and DRS (not accounting for all inputs, regulatory burden and compliance costs)
question
Cobb douglas Returns
should always have diminishing returns
question
Explicit Costs
direct, out of pocket payments for inputs
question
Implicit Costs
Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur
question
Sunk Costs
should be ignored
form of fixed cost
not considered in a shutdown
question
Sunk Cost fallacy
letting sunk costs affect a firms operating decisions
question
Short Run costs
Fixed input so there is come form of fixed cost
question
Total Cost (q) =
f(q) + a
VC + FC
question
Average Costs
(AFC, AVC, ATC) any costs divided by quantity produced (q)
question
Marginal Cost =
(∆TC)/ ∆Q = (∆FC)/∆q
(dTC)/(dq)
question
MC curve intersects ATC and AVC at their
Minimums
question
Long Run Costs
factors are variable
Minimize cost while meeting production target
question
Isocosts
all combinations of inputs that result in the same total expenditure
question
Costs are minimized at
MRTS = w/r
question
Long run expansion path
shows long-run total cost curve by plotting lowest cost association with each amount of total output
question
Where production is optimal (costs minimized without compromising production)
Where isocost is tangential to isoquant
question
tangency condition
MRTS = MPL/MPK = w/r
MPK/r = MPL/w
question
Cost Minimizing Bundle steps
1 - Find MRTS = MPL/MPK
2 - find optimal capital and labor ratio (MRTS = w/r)
3 - Use production function and target output to solve for optimal bundle - use optimal ratio from S2 to substitute in function
4 - calculate total cost
question
Short Run vs Long run expansion paths
LR - s shaped
SR - straight (Horizontal)

Long run marginal cost curve will be flatter than SRMC in general
question
Economies of Scale
Costs rise more slowly than production
LRMC < LRATC
question
Constant Economies of scale
costs rise at the same rate as output
LRMC = LRATC
question
Diseconomies of scale
costs rise more quickly than production
LRMC > LRATC
question
U shape of LRATC implies
cost per unit falls (economies of scale) and eventually as output rises considerably, diseconomies of scale take hold
question
Causing factors of diseconomies of scale
Overcrowding, over-utilization of capital, org complexity
question
Returns to scale vs economies of scale
RTS = how prod changes when all inputs are changed by a common factor
question
Economies of scope
refers to simultaneous production of multiple products at a lower cost than if a firm made each separately
question
Why a firm might observe economies of scope
Flexible inputs or production processes
expertise across several products/services (eg - life and auto insurance)
question
Perfect Competition Characteristics
Many firms, no product differentiation, no barriers to entry
question
Monopolistic Comp Characteristics
Many firms, product differentiation, no barriers
question
Oligopoly characteristics
Few firms, possible prod differentiation, some barriers to entry
question
5 conditions of perfect competition
1 - homogenous product, consumers indifferent
2 - many firms
3 - no barriers to entry OR exit - both long run
4 - complete info
5 - no transaction costs
question
PC firms are
price takers
no one firm can affect the market price by its outputs or price it buys inputs
question
Shutdown Rule - short run
If TR ≥ TVC then the firm will stay open
If TR<TVC the firm will shutdown
AKA if AVC curve is above the P,MR then it will shutdown
question
Short Run supply curve
Marginal Cost curve
question
Shutdown rule continuted
Firm will only produce when P> min(AVC)
question
All long run perfectly competitive firms earn
zero economic profit, but they will never earn negative economic profit
question
AVC and ATC are always
U shaped
question
Gap between ATC and AVC curves is the ___ which gets ___ as production increases
AFC, gets closer together
question
MC always intersects the __ and __ at their lowest points
AVC ATC
question
The long run TC curve is always ____ to the SR TC curve. This implies that the ____ will always envelope the _____.
less than or equal, LRATC curve, SRATC curve
question
LRMC =
derivative of LRTC
question
check for economies of scale
∫LRATC = LRATC'
FInd Q
∫LRATC'
see if x>0
if so Q = minimum
question
Where is a firm maximizing profit
MR =TC'=P
question
Minimum Price needed to produce?
AVC'
Check SOC to see its >0
Plug back into AVC
question
Why firms continue producing when economic profit is zero
Because its economic profit so it is still better than their next best option -> and could still be making an accounting profit depends on the firm
question
Income effect (on graph)
B - A"
question
Substitution Effect (on graph)
A" -A
question
Total Effect (on graph)
B -A
1 of 74
question
Total Effect
substitution effect + income effect
Price of one good changes relative to another
1)one good becomes more expensive, other is less expensive
question
Substitution effect
change in quantity of a good when that good price changes, holding income and utility constant
buy more of the cheaper good
question
Income effect
change in quantity demanded when theres a change in income, resulting from change in purchasing power
income doesnt actually change but consumer feels richer or poorer depending ∆ in purch power
question
Positive income effect
As a result from gains from trade real incomes rise --> Consumers buy even more.
question
Giffen Goods
goods that are exceptions to the law of demand where at very low prices, with consumers on low incomes and dependent upon the good for survival, as price rises, then so does demand
question
Compensating Variation
the amount of money one would have to give a consumer to offset completely the harm from a price increase
question
Equivalent variation
the amount of money one would have to take from a consumer to harm the consumer by as much as the price increase
question
CV =
Old utility at new prices
question
EV =
new utility at old prices
question
substitution effect
income effect
A -> A"
A" -> B
Should reflect eachother on either side
question
Normality of a good is determined by
Income effect
question
Labor-Leisure Model
...
question
Production Assumptions
- single good
-Capital (K) and Labor (L)
- outputs increase with inputs
-Inputs characterized by diminishing marginal returns
- firm can employ unlimited capital and labor at fixed prices
question
Production Function
Q = f(L,K)
question
Short Run vs Long run production
SR - atleast one factor is fixed
LR - both factors are variable
question
Marginal Product of Labor (MPL) =
(∆q)/(∆L)
- for continuous production function = (dq)/dL)
question
- we expect MPL to be positive but decreasing when capital is fixed
-increase at a decreasing rate
question
Long Run production outputs.. (isoquants)
Can be the same at different variables
- isoquants show combinations of labor that produce the same amount of output
- slope of isoquant shows tradeoffs at any point
question
Slope of the Isoquant =
MRTS
question
MRTS =
-∆K/∆L = (MPL)/(MPK)
describes amount of K needed to keep output constant given 1 unit change in L
question
Isoquant shapes - straight v curved
Straight - imply inputs are relatively substitutable
Curved - imply that inputs are relatively complementary
question
When MRTS is constant
perfect substitutes - traded off inconstant ratio
question
Perfect complements
must be used in a fixed ratio as a part of prod process
question
Returns to scale
change in output when all inputs are increased or decreased in the same proportion
question
Constant returns to scale
double inputs, doubles outputs
question
Increasing returns to scale (decreasing RTS)
changing all inputs by same proportion changes output more than proportionally (less than proportionally)
question
Norms in RTS
CRS is considered normal - still see IRS (learning by doing) and DRS (not accounting for all inputs, regulatory burden and compliance costs)
question
Cobb douglas Returns
should always have diminishing returns
question
Explicit Costs
direct, out of pocket payments for inputs
question
Implicit Costs
Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur
question
Sunk Costs
should be ignored
form of fixed cost
not considered in a shutdown
question
Sunk Cost fallacy
letting sunk costs affect a firms operating decisions
question
Short Run costs
Fixed input so there is come form of fixed cost
question
Total Cost (q) =
f(q) + a
VC + FC
question
Average Costs
(AFC, AVC, ATC) any costs divided by quantity produced (q)
question
Marginal Cost =
(∆TC)/ ∆Q = (∆FC)/∆q
(dTC)/(dq)
question
MC curve intersects ATC and AVC at their
Minimums
question
Long Run Costs
factors are variable
Minimize cost while meeting production target
question
Isocosts
all combinations of inputs that result in the same total expenditure
question
Costs are minimized at
MRTS = w/r
question
Long run expansion path
shows long-run total cost curve by plotting lowest cost association with each amount of total output
question
Where production is optimal (costs minimized without compromising production)
Where isocost is tangential to isoquant
question
tangency condition
MRTS = MPL/MPK = w/r
MPK/r = MPL/w
question
Cost Minimizing Bundle steps
1 - Find MRTS = MPL/MPK
2 - find optimal capital and labor ratio (MRTS = w/r)
3 - Use production function and target output to solve for optimal bundle - use optimal ratio from S2 to substitute in function
4 - calculate total cost
question
Short Run vs Long run expansion paths
LR - s shaped
SR - straight (Horizontal)

Long run marginal cost curve will be flatter than SRMC in general
question
Economies of Scale
Costs rise more slowly than production
LRMC < LRATC
question
Constant Economies of scale
costs rise at the same rate as output
LRMC = LRATC
question
Diseconomies of scale
costs rise more quickly than production
LRMC > LRATC
question
U shape of LRATC implies
cost per unit falls (economies of scale) and eventually as output rises considerably, diseconomies of scale take hold
question
Causing factors of diseconomies of scale
Overcrowding, over-utilization of capital, org complexity
question
Returns to scale vs economies of scale
RTS = how prod changes when all inputs are changed by a common factor
question
Economies of scope
refers to simultaneous production of multiple products at a lower cost than if a firm made each separately
question
Why a firm might observe economies of scope
Flexible inputs or production processes
expertise across several products/services (eg - life and auto insurance)
question
Perfect Competition Characteristics
Many firms, no product differentiation, no barriers to entry
question
Monopolistic Comp Characteristics
Many firms, product differentiation, no barriers
question
Oligopoly characteristics
Few firms, possible prod differentiation, some barriers to entry
question
5 conditions of perfect competition
1 - homogenous product, consumers indifferent
2 - many firms
3 - no barriers to entry OR exit - both long run
4 - complete info
5 - no transaction costs
question
PC firms are
price takers
no one firm can affect the market price by its outputs or price it buys inputs
question
Shutdown Rule - short run
If TR ≥ TVC then the firm will stay open
If TR<TVC the firm will shutdown
AKA if AVC curve is above the P,MR then it will shutdown
question
Short Run supply curve
Marginal Cost curve
question
Shutdown rule continuted
Firm will only produce when P> min(AVC)
question
All long run perfectly competitive firms earn
zero economic profit, but they will never earn negative economic profit
question
AVC and ATC are always
U shaped
question
Gap between ATC and AVC curves is the ___ which gets ___ as production increases
AFC, gets closer together
question
MC always intersects the __ and __ at their lowest points
AVC ATC
question
The long run TC curve is always ____ to the SR TC curve. This implies that the ____ will always envelope the _____.
less than or equal, LRATC curve, SRATC curve
question
LRMC =
derivative of LRTC
question
check for economies of scale
∫LRATC = LRATC'
FInd Q
∫LRATC'
see if x>0
if so Q = minimum
question
Where is a firm maximizing profit
MR =TC'=P
question
Minimum Price needed to produce?
AVC'
Check SOC to see its >0
Plug back into AVC
question
Why firms continue producing when economic profit is zero
Because its economic profit so it is still better than their next best option -> and could still be making an accounting profit depends on the firm
question
Income effect (on graph)
B - A"
question
Substitution Effect (on graph)
A" -A
question
Total Effect (on graph)
B -A

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