ECO 101

Study Guide for Exam 3

Costs of Production and Profit Maximization

You should be able to define, understand, and calculate the following items:

• total revenue
• total cost (as opportunity cost)
• profit (both accounting and economic)
• production function
• diminishing marginal productivity
• fixed cost (FC)
• variable cost (VC)
• average fixed cost (AFC)
• average variable cost (AVC)
• average total cost (ATC)
• marginal cost (MC).
• marginal revenue (MR)
• marginal profit (M)
• efficient scale of output.

Having calculated these variables, you should be able to plot them on a diagram or read the data from a diagram.

• Understand the formula for profit maximization? How is it used?

Competitive Markets

Economists place markets in different categories, depending on important characteristics. We have studied three market types: competitive, monopolistic, and monopolistically competitive. You should know the defining characteristics of each. In particular, with regard to competitive markets you should

• know whether competitive firms are price takers or price setters.
• know what a competitive firm's demand curve looks like.
• know what a competitive firm's marginal revenue curve looks like.
• be able to find the profit-maximizing level of output for a competitive firm.
• know what a competitive firm's short-run and long-run supply curves are.
• be able to determine the shut-down and exit prices for competitive firms.
• be able to determine the efficient scale of operation for a competitive firm.
• understand how the market supply curve is derived in a competitive market.
• understand the dynamic reaction of a competitive market to the existence of positive economic profits.
• understand the dynamic reaction of a competitive market to the existence of economic losses.
• be able to determine the long-run equilibrium position of a competitive firm.

Monopoly

A monopoly market is characterized by a single dominant producer. You should

• be able to list the major factors causing monopolies to arise and persist.
• be able to list the main characteristics of a monopolistic market.
• know what a monopolist's demand and marginal revenue curves look like.
• be able to determine the profit-maximizing output level of a monopolist.
• be able to determine the profit-maximizing price charged by a monopolist.
• be able to show graphically the amount of profit earned by a monopolist.
• understand how patents and copyrights act to create temporary monopolies and why consumers may benefit from such a system.
• understand the major feature characterizing a natural monopoly.
• be able to determine the welfare cost of monopoly.

Monopolistic Competition

Monopolistically competitive markets are, in major respects, like competitive markets, but in one respect resemble monopoly markets. You should

• know the identifying characteristics of a monopolistically competitive market.
• be able to determine the profit-maximizing output level and price of a monop comp firm.
• understand how the entry of a new firm into a monop comp market imposes a negative externality on existing firms in the market.
• understand how and why the long-run equilibrium situation in a monp comp market differs from the long-run situation in a monopolistic market.
• understand the relationship between P and ATC and P and MC in long-run equilibrium.
• be able to show the welfare loss generated by monop comp markets.
• understand why economists don't worry much about the static welfare losses in monop comp markets; what are the offsetting positive factors?
• know what is meant by "markup pricing."
• understand, in economic terms, what monop comp firms attempt to accomplish by advertising; in particular, how do they attempt to affect the demand curve?
• know the arguments used to criticize advertising and to defend advertising.
• understand how Frankie and Louie can sell Budweiser (or any other crazy ad campaign).
• understand the importance of brand names.

Consumer Choice

• Understand what a budget constraint is and how to create the equation given the prices of the goods and the budget.
• Be able to explain what an indifference curve is and what it represents.
• Understand why indifference curves cannot cross.
• Define "utility" and how it relates to an indifference curve map.
• Know what the consumer choice model does in terms of constrained utility optimization.
• Understand how the model changes as the price of a good changes and how a demand curve can be derived from this

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