Mangerial Economics

question

Successful operation requires manager to do what?

answer

optimally choose the quantity and types of inputs to use in the production process

question

The Production Function

answer

k = capital (machine)
L = labor (people)
Q = Level output produced in production

Q = F(k,L)
This is the max output produced with k units and L units

question

Short Run

answer

Fixed factors (fixed factors can not be changed)
Variable factors (inputs managers can adjust to alter production)
Short Run = time frame in which factors are fixed

question

Long Run

answer

Horizon over which the manager can adjust all factors of production
Example: Takes a company 3 years to acquire additional capital
(short run: under 3 years, long run: 3 years)

question

Total Product

answer

Max level of output that can be produced with a given amount of inputs

question

Average Product

answer

Measures of output produced per capital/labor
APκ = Q/K
APι = Q/L

(look at graph in notes)

question

Marginal Product

answer

the additional amount of product made by one additional input
MPκ = δQ/δK
MPι = δQ/δK

(look at graph in notes)

question

Value Marginal Product

answer

Value of the output produced by the last unit of an input

VMPι = P × MPι
VMPκ = P × MPκ

question

Cost Minimization

answer

Producing output at the lowest cost possible
→ producers concerned with cost minimization because of economic scarcity
→ if no scarcity producers wouldn't care about production cost
→ to maximize profit, minimize production cost

question

Cost Minimizing Input Rule

answer

To minimize cost of producing at a given level of output
*marginal product per dollar should be equal for all inputs

MPι/W = MPκ/r
or
MPι/MPκ = W/r

question

Cost Minimizing Input Rule Example

answer

Lawn Service: 5 small mowers and 2 large mowers

Marginal Product:
Small → 3 lawns per day
Large → 6 lawns per day

Rental Price
Small = $10/day
Large = $25/day

MPs → marginal product small mower
MPι → marginal product large mower
Ps = small $10/day (rental price)
Pι = large $25/day (rental price)

MPs/Ps = MPι/Pι = 3/$10 > 6/$25

Firm NOT cost minimizing
SHOULD USE FEWER LARGE AND MORE SMALL

question

Optimal Input Substitution

answer

To minimize cost of producing a given level of output, the firm should use less of an input and more of other inputs when that input price rises

question

Short Run

answer

period of fixed inputs (some)

question

Total Cost

answer

Sum of fixed and variable costs.
Total Costs in Short Run consists of
1. cost of fixed inputs (FC)
2. cost of variable inputs (VCQ)
→change when output changes

question

Average Fixed Costs

answer

AFC = FC/Q

question

Average Variable Costs

answer

Measure of variable costs per unit produced

AVC = VC(Q)/Q

question

Average Total Cost

answer

measure of total costs on per unit basis

ATC = C(Q)/Q
or
TC/Q
or
ATC = AVC + AFC

question

Marginal (Incremental) Costs

answer

the cost of producing an additional unit of output

MC = ∆C/∆Q

question

Sunk Costs

answer

a cost forever lost after paid
→irrelevant to decision making
→nonrefundable

question

Irrelevance of Sunk Costs

answer

Decision maker should ignore sunk costs to max profits or minimize losses

question

Cubic Cost Function

answer

provides reasonable approximation to any cost function

C(Q) = ƒ +aQ + bQ² + cQ³

a, b, c → constants
ƒ → fixed costs

question

Marginal Cost for Cubic Costs

answer

MC(Q) = a + 2bQ + 3cQ²

*MC(Q) = δC/δQ

question

Multiple Output Cost Functions Example

answer

Toyota produced cars, vans, SUV's, and trucks
Dell produces many computers and printers
Cost function for muli-product firm = C(Q₁,Q₂)
Q₁ = product 1 output

question

Economies of Scope

answer

If it is cheaper to produce two good together you have economies of scope (Pizza Hut and Taco Bell example)

Mathematically:
C(Q₁,0) + C(0,Q₂) > C(Q₁,Q₂)

question

Cost Complementarity

answer

When the marginal cost of producing one good is decreased by producing more of another good
EXAMPLE: studying for one test and it helps with another

δMC₁/δQ₂ < 0

δMC₁ → Marginal cost of good 1
δQ₂ → output of second good

question

Summary of the properties of Quadratic Multi-Cost Function

answer

1. complementarity when a < 0
2. economies of scope when ƒ - aQ₁Q₂ > 0

question

Perfect Competition

answer

a) market characteristics
b) market demand vs. firm demand
c) profit max rule
i. economic profits
ii. operating loss
iii. shut down rule
d) long run competitive equilibrium

question

Perfect Competition Key Conditions

answer

1. many buyers and sellers, each is "small" relative to market
2. each firm produced homogeneous product in market
3. buyers and sellers have perfect information
4. NO transaction costs
5. free entry/exit
→consumers view product of all forms in market as *perfect substitutes*
→perfect info: consumers know quality and price
→all firms charge same price and determined by buyers/sellers

question

Demand and Market and Firm level

answer

(look at graph in notes)

question

Maximizing Profits:Perfect Competition

answer

Demand for individual firms product = market price of output (P)
(Q) = output of firms, units

question

TOTAL REVENUE

answer

R = P(Q)

question

Marginal Revenue

answer

The change in revenue attributable to the last unit of output. For competitive firms MR = Market Price

question

Profits of perfectly competitive firm

answer

π = PQ − C(Q)

question

Profit Max. Under Perfect Comp.

answer

(look at graph in notes)

question

Competitive Output Rule:

answer

To maximize profits a perfectly competitive firm produces the output at which price equals marginal cost in the range over which marginal cost increases
P = MC(Q)

question

Minimizing Losses

answer

If losses are sustained in long run → firm should *exit*

question

Short Run Operating Loses

answer

Short Run → continue to produce
*if firm shuts down, losses = fixed costs
(look at graph in notes)

question

The Decision to Shut Down

answer

Shut down if AVC > Dƒ = Pι = MR
(look at graph in notes)

question

Short Run Out Decisions Under Perfect competition

answer

SHUT DOWN
if P < AVC
the firm should shut down

question

Long Run Decisions

answer

As more firms enter the industry, industry supply curve shifts→RIGHT
° lowers ↓ equilibrium price
°individual demand curve for a form shifts down ↓ LOWERS PROFIT

question

Entry and Exit: The Market and Firm's Demand

answer

(look at graphs in notes)

question

Long Run Competitive Equilibrium

answer

Perfectly competitive firms produce level of output such that
1. P = MC
2. P = min AC
(look at graph in notes)

question

Monopoly

answer

A market structure, single firm serves an entire market for a good that has no close substitutes

question

Monopoly Power

answer

Local Monopoly → Lubbock Power & Light

Market Demand for product = firm demand
Monopolists can change as much as they want (outside legal restrictions) BUT it is up to the consumer how much they purchase
*Monopolists are restricted by the consumers*

question

Patents and Other Legal Barriers

answer

°Government may grant individual firm a monopoly right
°Patent System: gives inventor of new product the exclusive right to sell a certain product for a given period

question

Comparative Advertising

answer

A form of advertising where a firm attempts to increase the demand for its brand by differentiating its product from competing brands

question

Brand Equity

answer

The additional value added to a product because of its brand

question

Niche Marketing

answer

A marketing strategy where goods and services are tailored to meet the needs of a particular segment of the market

question

Green Marketing

answer

A form of niche marketing where firms target products toward consumers who are concerned about environmental issues

question

Brand Myopic

answer

A manager or company that rests on a brand's past laurels instead of focusing on emerging industry trends or changes in consumer preferences

question

One Shot Games, Simultaneous-move

answer

(look at notes, table 4x4 graph)

question

Nash Equilibrium

answer

NO player can improve his payoff by unilaterally changing his own strategy, given other players strategy
Put yourself in rivals shoes: if you don't have a dominant strategy look at the game and determine opponents dominant strategy and go off that
(best he/she can do given other players decision)

question

Multistage Games

answer

Players makes sequential decisions rather simultaneously summarizes players, info, strategies, sequence of moves and payoffs
(example in notes, tree diagram)

question

Sub Game Perfect Equilibrium

answer

1. Nash Equilibrium
2. Neither player can improve by changing his strategy

question

Cournot Oligopoly

answer

Characteristics
1. Few firms in market serving many consumers
2. Forms produce either homo or differentiated products
3. Each firm believes rivals will hold their output constant if it changes its output
4. Barriers to entry EXIST

question

Reaction/Response Function

answer

Suppose 2 firms→ π max for firm 1 depends on firms 2's output level
→greater output level by firm 2
→lower π max for firm 1

Definition: Function defining π max level of output for a firm for a given output levels of another firm

π max level output for:
Firm 1: Q₁ = r₁ (Q₂)
Firm 2: Q₂ = r₂ (Q₁)

question

Collusion

answer

When a market is only dominate by a few firms, firms can benefit at cost of consumers by "agreeing" to restrict output and charge higher prices

question

Bertrand Oligopoly

answer

Characteristics
1. Few firms in market serving many consumers
2. Firms produce identical products and constant MC
3. Firms engage in price competition and react optimally to prices charged by competitors
4. Consumers have perfect information and NO transaction costs
5. Barriers to entry EXISTS

1 of 58

question

Successful operation requires manager to do what?

answer

optimally choose the quantity and types of inputs to use in the production process

question

The Production Function

answer

k = capital (machine)
L = labor (people)
Q = Level output produced in production

Q = F(k,L)
This is the max output produced with k units and L units

question

Short Run

answer

Fixed factors (fixed factors can not be changed)
Variable factors (inputs managers can adjust to alter production)
Short Run = time frame in which factors are fixed

question

Long Run

answer

Horizon over which the manager can adjust all factors of production
Example: Takes a company 3 years to acquire additional capital
(short run: under 3 years, long run: 3 years)

question

Total Product

answer

Max level of output that can be produced with a given amount of inputs

question

Average Product

answer

Measures of output produced per capital/labor
APκ = Q/K
APι = Q/L

(look at graph in notes)

question

Marginal Product

answer

the additional amount of product made by one additional input
MPκ = δQ/δK
MPι = δQ/δK

(look at graph in notes)

question

Value Marginal Product

answer

Value of the output produced by the last unit of an input

VMPι = P × MPι
VMPκ = P × MPκ

question

Cost Minimization

answer

question

Cost Minimizing Input Rule

answer

To minimize cost of producing at a given level of output
*marginal product per dollar should be equal for all inputs

MPι/W = MPκ/r
or
MPι/MPκ = W/r

question

Cost Minimizing Input Rule Example

answer

question

Optimal Input Substitution

answer

To minimize cost of producing a given level of output, the firm should use less of an input and more of other inputs when that input price rises

question

Short Run

answer

period of fixed inputs (some)

question

Total Cost

answer

Sum of fixed and variable costs.
Total Costs in Short Run consists of
1. cost of fixed inputs (FC)
2. cost of variable inputs (VCQ)
→change when output changes

question

Average Fixed Costs

answer

AFC = FC/Q

question

Average Variable Costs

answer

Measure of variable costs per unit produced

AVC = VC(Q)/Q

question

Average Total Cost

answer

measure of total costs on per unit basis

ATC = C(Q)/Q
or
TC/Q
or
ATC = AVC + AFC

question

Marginal (Incremental) Costs

answer

the cost of producing an additional unit of output

MC = ∆C/∆Q

question

Sunk Costs

answer

a cost forever lost after paid
→irrelevant to decision making
→nonrefundable

question

Irrelevance of Sunk Costs

answer

Decision maker should ignore sunk costs to max profits or minimize losses

question

Cubic Cost Function

answer

provides reasonable approximation to any cost function

C(Q) = ƒ +aQ + bQ² + cQ³

a, b, c → constants
ƒ → fixed costs

question

Marginal Cost for Cubic Costs

answer

MC(Q) = a + 2bQ + 3cQ²

*MC(Q) = δC/δQ

question

Multiple Output Cost Functions Example

answer

Toyota produced cars, vans, SUV's, and trucks
Dell produces many computers and printers
Cost function for muli-product firm = C(Q₁,Q₂)
Q₁ = product 1 output

question

Economies of Scope

answer

If it is cheaper to produce two good together you have economies of scope (Pizza Hut and Taco Bell example)

Mathematically:
C(Q₁,0) + C(0,Q₂) > C(Q₁,Q₂)

question

Cost Complementarity

answer

question

Summary of the properties of Quadratic Multi-Cost Function

answer

1. complementarity when a < 0
2. economies of scope when ƒ - aQ₁Q₂ > 0

question

Perfect Competition

answer

a) market characteristics
b) market demand vs. firm demand
c) profit max rule
i. economic profits
ii. operating loss
iii. shut down rule
d) long run competitive equilibrium

question

Perfect Competition Key Conditions

answer

question

Demand and Market and Firm level

answer

(look at graph in notes)

question

Maximizing Profits:Perfect Competition

answer

Demand for individual firms product = market price of output (P)
(Q) = output of firms, units

question

TOTAL REVENUE

answer

R = P(Q)

question

Marginal Revenue

answer

The change in revenue attributable to the last unit of output. For competitive firms MR = Market Price

question

Profits of perfectly competitive firm

answer

π = PQ − C(Q)

question

Profit Max. Under Perfect Comp.

answer

(look at graph in notes)

question

Competitive Output Rule:

answer

To maximize profits a perfectly competitive firm produces the output at which price equals marginal cost in the range over which marginal cost increases
P = MC(Q)

question

Minimizing Losses

answer

If losses are sustained in long run → firm should *exit*

question

Short Run Operating Loses

answer

Short Run → continue to produce
*if firm shuts down, losses = fixed costs
(look at graph in notes)

question

The Decision to Shut Down

answer

Shut down if AVC > Dƒ = Pι = MR
(look at graph in notes)

question

Short Run Out Decisions Under Perfect competition

answer

SHUT DOWN
if P < AVC
the firm should shut down

question

Long Run Decisions

answer

As more firms enter the industry, industry supply curve shifts→RIGHT
° lowers ↓ equilibrium price
°individual demand curve for a form shifts down ↓ LOWERS PROFIT

question

Entry and Exit: The Market and Firm's Demand

answer

(look at graphs in notes)

question

Long Run Competitive Equilibrium

answer

Perfectly competitive firms produce level of output such that
1. P = MC
2. P = min AC
(look at graph in notes)

question

Monopoly

answer

A market structure, single firm serves an entire market for a good that has no close substitutes

question

Monopoly Power

answer

question

Patents and Other Legal Barriers

answer

°Government may grant individual firm a monopoly right
°Patent System: gives inventor of new product the exclusive right to sell a certain product for a given period

question

Comparative Advertising

answer

A form of advertising where a firm attempts to increase the demand for its brand by differentiating its product from competing brands

question

Brand Equity

answer

The additional value added to a product because of its brand

question

Niche Marketing

answer

A marketing strategy where goods and services are tailored to meet the needs of a particular segment of the market

question

Green Marketing

answer

A form of niche marketing where firms target products toward consumers who are concerned about environmental issues

question

Brand Myopic

answer

A manager or company that rests on a brand's past laurels instead of focusing on emerging industry trends or changes in consumer preferences

question

One Shot Games, Simultaneous-move

answer

(look at notes, table 4x4 graph)

question

Nash Equilibrium

answer

question

Multistage Games

answer

Players makes sequential decisions rather simultaneously summarizes players, info, strategies, sequence of moves and payoffs
(example in notes, tree diagram)

question

Sub Game Perfect Equilibrium

answer

1. Nash Equilibrium
2. Neither player can improve by changing his strategy

question

Cournot Oligopoly

answer

question

Reaction/Response Function

answer

question

Collusion

answer

When a market is only dominate by a few firms, firms can benefit at cost of consumers by "agreeing" to restrict output and charge higher prices

question

Bertrand Oligopoly

answer

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