Download CHAPTER #20 SHORT ANSWER ESSAY SOLUTIONS

CHAPTER #20 SHORT ANSWER ESSAY SOLUTIONS
1. The opportunity cost of producing a product refers to alternative uses (other
goods/services) resources could have been used for once you make a choice to use them
in producing some good or service. Once you decide to produce something you give up
alternative products/services that could have been made with those resources. Explicit
costs are the cost of purchasing resources you do not own, while implicit costs represent
the opportunity cost of self owned resources used in the production process. Implicit
costs are determined by the value of their alternative use once you choose to use them. If
I quit my job teaching to run start and run a business, my opportunity cost is giving up
my teaching salary.
2. Normal profit refers to the opportunity cost of self owned resources in producing
goods/services which are implicit costs, while economic profits are the difference
between revenues and the sum of explicit plus implicit costs.
3. In long run a firm can adjust all resources or factors of production, while in the short run
at least one factor of production (usually plant) is fixed. In the short run a firm can adjust
(vary) the quantity of variable resources in the production process. There is no set time
for the “short run”; it just represents the time where the one fixed resource does not
change. Once the firm changes it, they are in the long run.
4. The distinction between the short run and long run is important, because in the short run
the “law of diminishing returns” is applicable, while in the long run it is not.
5. The law of diminishing returns states that as you add additional variable inputs to a fixed
input; marginal output will increase for a while; but eventually it will diminish. Marginal
output eventually diminishes because of congestion impacts the production facility;
and/or there is insufficient capital for the amount of labor present.
6. A fixed cost is a cost which does not vary with output; such as the rental payment of the
storefront of a business. Variable costs, are costs which do in fact change as output
changes. This includes inputs such as labor, explicit resources, etc…
7. Short run total costs are partly fixed since total costs include a firms fixed costs, and they
are partly variable because total costs include the costs of the variable resources as well;
which change as output changes.
8. Short run variable costs increase at first by decreasing amounts and later by increasing
amounts due to the law of diminishing returns. Early on in production marginal product
increases as additional inputs (variable) are added. Variable costs thus decrease. Later on
as marginal product diminishes with added resources, variable costs will thus increase.
This as mentioned is due to the law of diminishing returns.
9. The behavior of short run variable costs directly affects the behavior of short run total
costs because total costs are the sum of fixed costs plus variable costs. Since fixed costs
don’t change, short run total costs only change due to changes in variable costs.
10. Short run average fixed costs decrease as output increases. Average variable costs are
high at low levels of output but diminish reaching a low point, then increasing again due
to the law of diminishing returns. Average total costs are high at low levels of output
but diminish reaching a low point, then increasing again due to the law of diminishing
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returns at higher levels of output. Marginal costs fall initially as output increases and
then rise as output increases due to the law of diminishing returns.
Marginal product is the additional output yielded by adding an additional variable input;
while marginal cost represents the cost of that added output. Average product is output
per input (usually labor), while average variable cost is the total variable cost divided by
output. When marginal product is rising, marginal cost is falling, and when average
product is rising average variable product is falling. The opposite is true in both cases.
The precise relation between marginal cost and average variable cost and average total
cost is that when marginal cost is below AVC and ATC; they will be decreasing.
Eventually marginal cost will be equal to AVC/ATC and cross them at their minimum
point; because once MC is above either curve it will begin to pull it up; since MC is a
component of each curve.
When the price of a variable input increases the MC, ATC, and AVC shift upward while
the AFC remains constant. When input prices decrease, the opposite will occur in respect
to the above curves.
The long run average cost curve shows possible minimum ATC’s at various levels of
output. The relation between long run average cost curve and short run ATC schedules of
different sized plants a firm might build is that points on the LRATC represent minimum
ATC on the various short run ATC schedules of the various plants.
The LRATC is “U” shaped because at lower levels of output a firm achieves economies
of scale, and eventually at higher levels of output diseconomies of scale.
Economies of scale refers to the downward sloping portion of the LRATC, where
increasing output leads to lower ATC. Diseconomies of scale refers to increasing ATC on
the upward sloping portion of the LRATC as output inceases.
Economies of scale are realized due to labor specialization, managerial specialization,
and greater efficiency.
Diseconomies of scale are generated by difficulty in controlling a larger plant generating
efficiency loss, multiple and often offsite management levels, and alienated workers with
low morale.
Minimum efficient scale refers to the lowest level of output a firm can reach lowest ATC
on its LRATC. The output range of MES determines the size of possible firms in the
industry, and where diseconomies of scale begin (at the end of MES).
Read applications and illustrations. (p.394-396)
CHAPTER #21 SHORT ANSWER ESSAY SOLUTIONS
1. The four market structures are oligopoly, pure competition, monopoly, and monopolistic
competition. For characteristics of each refer to (p.400)
2. The four characteristics of perfect competition are; a) very large number of independent
sellers, b) standardized product, c) firms are price takers since each has only a small
fraction of the market, d) free entry and exit to market as no significant, cost, legal, or
technological barriers exist.
3. Students study perfect competition even though its rare because it’s a good place to
introduce price/output decision making, it provides a standard to for evaluating
efficiency, and helps us understand markets such as metals, agriculture goods, fish, and
foreign exchange.
4. Price elasticity of demand of purely competitive firms is perfectly elastic, meaning that
firms can sell as many products as they can at the market price. In a perfectly competitive
market average revenue, and marginal revenue are one in the same. As output increases
total revenue increases while, average and marginal revenue stay constant since they are
equal to price.
5. The total revenue/total cost approach to profit maximization says to simply produce an
output where the difference between total revenue and total cost is greatest. This can be
spotted in tabular form, or by graphing the total cost and total revenue curves.
6. The marginal revenue/marginal cost approach simply says that a firm should produce
where the marginal revenue of the last unit produced is equal to the marginal cost of that
last unit. This approach is consistent with the total cost/total revenue method mentioned
in #5.
7. Refer to #6 above for description of the MR=MC rule. The rule can be restated for
purely competitive markets as P=MR=MC. In most data the point at which MR=MC will
be at a fractional level of output; therefore the firm should produce the last whole unit of
output where MR>MC. Rule works for other market structures as well.
8. Firms wish to maximize total profit, not per unit profit, which may come at a lower level
of output than MR=MC=P.
9. A firm is willing to produce at a loss in the short run, rather than shutting down when the
loss is not greater than fixed costs, since shutting down the firm would in fact have to pay
the higher fixed costs!
10. The supply curve of an individual firm in the short run is its MC curve above AVC (the
shut down point). The supply curve for the industry is the sum of all of the individual
supply curves of all firms in the industry.
11. Equilibrium price and output of purely competitive industry in the short run is where the
sum of the individual supply curves for the firms in the industry intersect the industry
demand curve. Economic profits in the industry could be either negative or positive.
12. Under purely competitive conditions MR=MC is the same as P=MC, since purely
competitive firms must take the market price since each contributes only a small share of
industry output. Therefore for each additional unit sold the marginal revenue (change in
revenue) is equal to the price. In addition the Demand curve for the individual firms is
completely elastic (horizontal) at the price; since the firms must take the market price.
13. Important distinctions between the short run and long run in pure competition is in the
short run, the number of firms in the industry is fixed, each having a fixed ,unalterable
plant, and if they’d like shut down. While in the long run firms can enter and exit, and
their plants can be altered; modified/increased. In the short run; equilibrium is when the
sum of the firms in the industry’s supply curves intersects the industry demand curve;
yielding profits/losses. In the long run equilibrium is the same, except the number of
firms won’t be the same as some will have entered (following economic profits) or exited
(escaping losses), and remaining firms at equilibrium will be earning normal (zero
economic) profits.
14. Refer to #13. What forces a firm into long run equilibrium earning normal profits is the
entry or exiting of other firms. Entry will eliminate existing firms economic profits,
while exit of firms will reduce economic losses. The end result is that after this long run
adjustment, remaining firms earn normal profits.
15. A constant cost industry is an industry in which entry or exit of firms in the industry has
no change of input prices. This is true for an industry whose demand for a resource is
small in relation to overall demand for that resource. An increasing cost industry is where
input costs increase as firms enter the industry and drop as they leave. Most industries are
increasing cost as when more firms enter in response increased demand, the demand for
inputs rises, increases their price. This is true for industries where inputs are not readily
increased.
16. Productive efficiency refers to a situation in the economy when firms are producing at
minimum atc in the long run; that is goods are being produced in their least costly way.
17. The conditions for allocative efficiency are where firms produce output where MC = MB
(price). Since consumers are willing to buy a good at a given price, they are indicating the
perceived benefit at the cost producers are willing to incur. Since producers and consumers are in
equilibrium (in a sense) resources are being allocated in the exact amount society wishes, at a cost
producers are willing to incur. If the equality MB=MC is not met, there will be either
underproduction, or overproduction of the good/service and allocative efficiency will not be
attained. A purely competitive economy would be efficient in that both productive and allocative
efficiency would be obtained.
18. Over allocation of resources in producing a product results when MC>MB; thus businesses
produce more goods than society desires. This will shift the supply curve for the industry right;
lowering the price, leading some firms to suffer losses, and exiting the industry until equilibrium
is reached (MB=MC), eliminating the problem. On the other hand if MC<MB, resources will be
under allocated to produce the product, causing its price to increase, thus attracting more firms to
the industry, and increasing supply; thus solving the problem.
19. Changes in supply and demand or a product (or resource) in purely competitive markets lead
to changes in price (profits/losses) for existing firms; leading to entry or exit of the industry.
Entry (profits), or exit for losses.
20. Pure competition maximizes consumer and producer surplus because total MB as represented
by points on the demand curve equals total marginal cost, as represented by points on the supply
curve; thus consumer and producer surplus are realized at the equilibrium output