Download Theory of the Firm - Unit Review Questions (Answers)

Theory of the Firm – Unit Review Questions
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Note #1: This does not include price discrimination and several ideas from the beginning of
the unit (e.g. calculating costs, etc.)
Note #2: This only a supplement to the Microeconomics study guide. Be sure that you
understand all of the key concepts from that study guide prior to the summative assessment.
EQUATIONS/FORMULAS
1. Allocative efficiency
a. MC = AR (MC = P) OR MSB = MSC
2. Productive efficiency
a. MC = ATC (MC = AC).
In long run, P = ATC
3. Abnormal (economic profit)
a. TR > TC (AR > AC)
4. Economic Costs
a. (Explicit costs + Implicit costs)
5. Normal profit
a. TR = TC (AR = AC)
6. Loss
a. TC > TR (AC > AR)
7. Profit-maximizing level of output
a. Level of output where TR-TC is as large as possible
b. Level of output where MR = MC
8. Loss-minimizing level of output
a. Level of output where TC-TR is as small as possible
b. Level of output where MR = MC
9. Shut-down price
a. Where P = minimum AVC in short run
i. (If asked to only diagram one shut-down price, use the short term!)
10. Break-even point
a. Where P = minimum ATC
i. In long run, if P is below min. ATC, shut it down!
11. AC
a. TC/Q
12. AR
a. TR/Q
b. (more simply… it is just P)
13. MR
a.
14. TR
a. PQ (@ AR where MR = MC)
15. TC
a. PQ (@ AC where MR = MC)
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COMPETITION TYPES
Use the following letters to answer each Q:
 PC
= perfect competition
 MC = monopolistic competition
 O
= oligopoly
 M
= monopoly
16. Product differentiation
a. MC, M, (usually but not always) O.
17. No product differentiation
a. PC
18. Productive efficiency in long run
a. PC
19. Allocative efficiency in long run
a. PC
20. Guarantees allocative efficiency in short run
a. PC (@ same point that MC = AR, MC is = to MR)
21. Guarantees productive efficiency in short run
a. None! (MC may = AC @ point above or below where MC = MR)
22. Only normal profit in long run
a. PC, MC
23. Abnormal profit possible in long run
a. O, M
24. Non-price competition
a. MC, O, M (if not using strict definition of monopoly)
25. Price competition
a. MC, O (but prices are often rigid), M (if not using strict def. of monopoly)
26. No barriers to entry
a. PC, MC
27. High barriers to entry
a. O, M
28. Entry to industry is blocked
a. M
29. Illegal in most countries
a. M, Collusive Os
30. CR4 = 50%
a. O
31. CR4 = 0%
a. PC, possible MC
32. CR1 = 100%
a. M
33. CR1 = 84%
a. Could be seen as a M
34. Price is constant
a. PC
35. Price is often rigid but can move up or down if marginal costs reach certain points
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a. O
36. Marginal and average revenue is consistently negatively (downward) sloping
a. M, MC (M is more inelastic due to less adequate substitutes available. O isn’t
in here b/c its MR is vertical for a bit)
37. All producers and consumers have a perfect knowledge of the market
a. PC
38. Advertising is used
a. MC, O, & usually M
39. Brand loyalty occurs
a. MC, O, & usually M
40. Patents are obtained
a. O & M and (sometimes) MC
41. A large number of sellers
a. PC & MC
42. A small number of sellers dominate the market
a. MC, O, & usually M
43. One seller dominates
a. M or possibly O (could lead to tacit collusion, price leadership)
44. Price takers
a. PC
45. Price makers
a. M, O, MC (MC has the some price-making power but not near as much as a M)
46. A cartel
a. O
47. A diagram of a cartel looks like this diagram
a. M
48. Kinked demand curve
a. O
49. Perfectly elastic demand curve
a. PC
50. Can lose money in the short run
a. PC, MC, O, M
51. 1 that is most associated with wheat sold in Central Asia
a. PC
52. 1 that is most associated with shampoo sold in London
a. O (MC could be a good guess as well)
53. 1 that is most associated with selling of jiaozi in Guangzhou
a. MC
54. 1 that is most associated with internet searches outside of China
a. M (Google. O could be argued as well)
55. 1 that is most associated with automobile production in Japan
a. O
56. 1 that is most associated with providing electricity in Guangzhou
a. M
57. 1 that is most associated with selling socks in Guangzhou
a. MC
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DEFINITIONS
Define the following terms:
58. normal profit
a. “zero economic profit”
b. DEFINITION #1:
i. Minimum amount of revenue a firm must receive so it will keep running
(instead of shutting down)
c. DEFINITION #2:
i. Amount of revenue that covers all implicit costs, especially
entrepreneurship
59. abnormal (economic) profit
a. Profit above normal (zero) profit when total revenues exceed total costs, including
both explicit and implicit costs.
60. oligopoly
a. Occurs when a large proportion of industry’s output is shared by a small number
of firms
61. natural monopoly
a. A natural monopoly is a firm that has economies of scale so large that it is possible
for the single firm alone to supply the entire market at a lower average cost than 2
or more firms. In other words, there are only enough economies of scale available
in the market to support one firm.
62. allocative efficiency
a. Marginal benefit of what consumers receive is = to marginal cost for producers
63. Productive efficiency
a. Production takes place at minimum average total cost. Firms produce @ the lowest
possible cost. Production of 1 good uses the least amount of resources possible.
64. formal collusion
a. An agreement between firms to limit competition, increase monopoly, & increase
profits. This occurs in the form of a cartel. Formal collusion is illegal in most
countries.
65. consumer surplus
a. the highest price consumers are willing to pay for a good minus the price actually
paid
66. producer surplus
a. the price received by firms for selling their goods minus the lowest price that they
are willing to accept in order to produce the good
67. tacit collusion
a. An informal agreement between firms to limit competition, increase monopoly, &
increase profits. This often involves price leadership by a dominant firm.
68. non-collusive oligopoly
a. When oligopolistic firms do not agree, whether formally or informally, to fix
prices or collaborate in some way
69. satisficing
a. The idea that no one goal, including profits, is dominant in a firm. Instead,
compromises happen where many different objectives are pursued at a
satisfactory, rather than a maximum level.
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70. Revenue maximization
a. The act of gaining the highest revenue possible, even if it is not at the point of
profit maximization where MR = MC. This is often favored by managers and
employees more than owners because (1) sales are easier to measure than profits,
(2) the opportunities for commissions and bonuses, and the (3) feeling of success.
71. Growth maximization
a. The act of growing bigger as a firm. This is favored by owners as they benefit
from lower costs associated with increasing economies of scale, greater market
power, and ability to diversify (less dependence on a single product). Managers
also enjoy this because it improves their chances for promotion, higher salaries,
and greater individual power.
72. Corporate social responsibility
a. When a firm acts to either avoid socially undesirable activities (e.g. pollution, poor
working conditions) or to do socially desirable activities (e.g. support for human
rights/charities).
73. Increasing returns to scale
a. Total output in the long run increases more than proportionately when compared
to additional inputs
74. Decreasing returns to scale
a. Total output in the long run increases less than proportionately when compared to
additional inputs
75. Diminishing marginal returns
a. Marginal output in the short run will eventually decrease as additional variable
inputs are added to fixed inputs.
76. Economies of scale
a. Decreases in average costs of production over long run as a firm increases all its
inputs.
DIAGRAMS
Draw & be able to explain the following diagrams. Answer the associated Qs (if asked)
77. Total revenue for (a) perfectly competitive firm and (b) for monopoly/monopolistic
competition/oligopoly.
a. Be able to draw each curve with and without total costs included.
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78. Simple diagram of allocative efficiency for a perfectly competitive market.
79. Natural monopoly (how is it similar to & different than a regular monop. diagram?)
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80. Where on a monopoly/monopolistic competition’s AR curve is PED elastic, unit elastic,
and inelastic?
81. Perfectly competitive firm at or below shut-down price
82. Perfectly competitive firm above shut-down price but below break-even point
83. Perfectly competitive firm at or above break-even point
84. Perfectly competitive industry’s supply/demand curve next to an individual firm’s
demand curve.
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85. Perfectly competitive firm making abnormal profit or taking a loss in the short run
86. Monopoly (and/or monopolistically competitive firm and/or cartel) making abnormal
profit in the short run (or long run for a monopoly)
87. Monopoly (and/or monopolistically competitive firm and/or cartel) operating at a loss in
the short (or long run for a monopoly)
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88. Oligopoly w/kinked demand curve
a. Why elastic above price? (Consequences if price is set here?)
b. Why inelastic below price? (Consequences if price is set here?)
89. Long run equilibrium in perfect competition (showing normal profit). Also, be able to
demonstrate where efficiencies should be located.)
90. Long run equilibrium in monopolistic competition (shows normal profit) Also, be able to
demonstrate where efficiencies should be located.
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