Essentials of Economics.

Chapter 7:
Inputs are the basic activity of a firm and they are workers, machines, and
natural resources that help produce the outputs of the goods and services.
A firm's technology is the process it uses to turn inputs into outputs, it
depends on factors like the skills of the managers, the training of the workers
and the speed and efficiency of the machinery and equipment. Technological
change refers to a change in the ability of a firm to produce a given kevel of
output with a given quantity of inputs, these changes can be positive as well as
negative, and it will depend on the type of workers, and managers hired but
also the machinery used.
Stockouts refer to sales that are being lost because the goods consumers
want to buy are not on the shelf.
(Just in time inventories are the one that receive the goods from the suppliers
just when they are about to run out of it.)
The short run and the Long run in economics:
The short run is the period of time during which at least one of a firms inputs
is fixed, it does not change in time like its physical plant, factory store or office,
but the number of workers hired are variable.
In the long run a firm can vary all its inputs, adopt new technologies, and
increase or decrease the size of its plants or physical space.
The period of time of a short run and a long run varies in different firms, and it
depends on what the firm produces.
Total costs are the cost of all the inputs a firm uses in production .
The cost of the fixed inputs are the fixed costs, these are the costs that
remain constant as output changes. For example: Leases payments for factory
or retail space, payments for insurance, and payments for advertising.
And the costs of variable inputs are the variable costs, this means the costs
changes when the outputs changes. For example: Labor costs, raw material
costs, costs of electricity and other utilities.
Variable costs and fixed costs vary depending on the industry.
Total Costs = Fixed Costs + Variable Costs
Opportunity cost is the highest valued alternative that must be given up to
engage in an activity.
When a firm spends money, it incurs an explicit cost. It might also be called

accounting costs. Ex: Wages, payments of rent and electricity.

When a firm experiences a non monetary opportunity cost, it incurs and implicit
cost. Ex: economic depreciation, wages given up to make the business.
Only the explicit costs are used in accounting in order to keep the company's
financial records and for paying taxes.
Economic costs include both accounting costs and implicit costs.
Production function is the relationship between the inputs employed by a
firm and the maximum outputs it can produce with those inputs.
The average total cost of a firm is always equal to its total cost divided by the
quantity of outputs produced. ATC= TC/Q
The marginal product of labor and the average product of labor.
The additional output a firm produces as a result of hiring one more worker is
called the marginal product of labor. It is calculated by determining how much
total output increases as each additional worker is hired.
Division of labor is dividing the tasks to be performed by the workers
employed. Specialization is someone who focuses on one tasks and becomes
skilled at doing it quickly and efficiently.
Law of diminishing returns is the principle that, at some point, adding more of a
variable input, such as labor, to the same amount of a fixed input, such as
capital, will cause the marginal product of the variable input to decline.
The average product of labor is the total output produced by a firm divided by
the quantity of workers.
Whenever the marginal product of labor is greater than the average product of
labor, the average product of labor must be increasing , and vice versa.
Relationship between short-run production and short- run cost.
Marginal cost is the change in a firm's total cost from producing one more unit
of a good or service. We can calculate marginal cost for a particular increase in
output by dividing the change in cost by the change in quantity of output.
When the marginal product of labor is rising, the marginal cost of output is
falling.
When the marginal product of labor is falling, the marginal cost of production is
rising.
Marginal cost equals average cost when average total cost is at its lowest
point.

Average fixed cost: Fixed costs divided by the quantity of output produced =
FC/Q
Average variable cost: Variable costs divided by the quantity of output
produced. = VC/Q
Average total Costs= AFC+AVC

The marginal cost, average total cost and average variable cost are all
U-shaped graphs.
MC curves intersects the AVC and ATC curves at their minimum point.
When MC is above the AVC or ATC it causes them to increase, therefore
when they meet it must but at the minimum point.
As output increases, AFC gets smaller, because in calculating average
fixed cost we are dividing something that gets larger with something
that remains constant.
As output increases, the difference between average total cost and
average variable cost decreases. This happens because the difference
between average total cost and average variable cost is average fixed
cost.

Costs in the Long-Run

In the Long-run, all cost are variable. There are no fixed cost in the long run.
Therefore average total cost is equal to average variable cost.
Economies of Scale
The long run average cost curve shows the lowest cost at which a firm is able
to produce a given level of output in the long run when no inputs are fixed.
Economies of scale is the situation when a firms long-run average cost falls as
it increases output.
The greater the economies of scale, the fewer the number of firm there would
be in the industry.
Economies of scale exist when a firm's long run average cost fall as it increases
output

CHAPTER 8

Firms in Perfectly Competitive Markets.

"If people see an economic opportunity, usually it only lasts for a few years."
Throughout the economy, entrepreneurs are continually introducing new
products, which when successful, enable them to earn economic profits in the
short run. But in the long run, competition among firms force prices to the level
where they just cover the costs of production.
Firms in perfectly competitive industries are unable to control the prices of the
products they sell and are unable to earn an economic profit in the long run.
This happen because firms in the same industry sell identical products and it is
easy for new firms to enter these industry.
But most of the industry are not perfectly competitive. In most industries, firms
do not produce identical products, and in some industries, it may be difficult for
new firms to enter.
Any industry has three economic characteristic which are:
1. The number of firms in the industry.
2. The similarity of the good or service produced by the firms in the
industry.
3. The ease with which new firms can enter the industry.
Perfect Competition has many numbers of firms with many buyers whom are
small compared with the power of the market because the fraction they buy is
very tiny compared with the total production. This firms have identical products
and the ease of entry is very high because there are no barriers to new firms
entering the market. For example: Wheat, Apples.

The prices in this industry are determined by the interaction of demand and
supply, and the action of any single consumer or firm have no effect on the
market price.
Consumer and firms have to accept the market price if they want to buy or sell
in a perfectly competitive market.
A firm in a perfectly competitive market can sell as much as it wants without
having to lower its price, but if it tries to raise its price, it won't sell anything at
all because consumers will switch to buying from the competition, this effect is
called the price taker ( the firm will have to charge the same price as every
other firm in the market). This happens because the market supply curve for
wheat will not shift by enough to change the equilibrium price by even 1 cent.
The demand curve in a single perfectly competitive firm is horizontal, it is not
affected by the quantity of products sold because it will always be the same
price. But the demand curve of the industry is downward-sloping.
Profits in perfectly competitive market is the difference between total revenue
and total costs.
Profit= TR-TC.
Profit=( P-ATC)*Q
In a graph the height equal to the difference between price and average total
cost and a base equal to Q represents the profit.
Which means to maximize the profits the firm should produce up to the point
where the difference between the total revenue received and the total costs is
as large as possible.
Average revenue is the total revenue divided by the quantity of products
sold.
Marginal revenue is the change in the total revenue from selling one more
product.
The marginal revenue curve for a perfectly competitive firm is the same as its
demand curve
The profit maximizing level of output is where the difference between total
revenue and total costs is the greatest.
The profit maximizing the level of output is also where the marginal revenue
equals marginal cost or MR=MC.
For a firm in a perfectly competitive industry, price equal to marginal revenue,
so the price would also be equal to marginal cost.

P > ATC means the firm makes profit.

P = ATC means the firm breaks even (TC=TR)
P < ATC means the firm experiences losses.

Monopolistic Competition are industries that sell products that are

differentiated, rather than identical there are many numbers of firms and the
ease of entry is high. For example: DVDs, Restaurants.
Oligopolies are industry that have a few number of firms, that their product can
be identical or differentiated and that the ease of entry to the industry is low.
For example: Computers, automobiles.
Monopolies is an industry that only has one firm and the type of product is
unique, also the ease of entrance is block so there is not another industry with
the same product. For example: First class mail delivery, tap water.

Deciding Whether to Produce or to Shut Down in the Short Run

If a firm is experiencing losses it has two options, it might consider to stop

production temporarily or to continue producing.
If the firm decides to shut down, it must still pay its fixed costs, therefore if a
firm does not produce, it will suffer a loss equal to its fixed costs.
If by producing, the firm would lose and amount greater than its fixed costs, the
firm should shut down.
A firm will be able to reduce its loss below the amount of its total fixed costs by
continuing to produce, provided the total revenue it receives is greater than its
variable cost. A firm can use the revenue over and above variable cost to cover
part of its fixed cost. In this case, the firm will have a smaller loss by continuing
to produce than if it shut down.
Analyzing the firm's decision to shut down we are assuming that its fixed costs
are sunk cost ( a cost that has already been paid and cannot be recovered.)
and that the firm cannot recover the costs by shutting down.
For any firm, whether total revenue is greater or less than variable costs is the
key to deciding whether to shutdown. As long as a firm's total revenue is

greater than its variable costs, it should continue to produce no matter how
large or small its fixed costs are.
A firm with losses in a perfectly competitive market cannot raise its prices,
because it would lose all its customers and its sales would drop to zero.

THE SUPPLY CURVE OF A FIRM IN THE SHORT RUN

The supply curve for a firm tells us how many units of a product the firm is
willing to sell at any given price. The marginal cost curve for a firm in a
perfectly competitive market tells us the same thing. Therefore, a perfectly
competitive firm's marginal cost curve is also its supply curve.
If the price drops below average variable cost, the firm will have a smaller loss
if it shuts down and produces no output. So, the firm's marginal cost curve is
its supply curve only for prices above or average variable cost.
Marginal cost curve intersects the average variable cost where the average
variable cost curve about the minimum point. Therefore, the firm's supply
curve is its marginal cost curve about the minimum point of the average
variable cost curve.
The shutdown point, is the minimum point on a firm's average variable cost
curve; if the price falls below this point, the firm shuts down production in the
short run.
Entry and Exit of Firms in the Long Run

Economic profit: A firm's revenue minus all its costs, implicit and explicit.
The more firms there are in an industry, the further to the right the market
supply is, and more firms will enter the market which will shift the market
supply to shift to the right, and more firms will continue to enter the industry
up to the point where the market price and demand falls down and the new
equilibrium won't have any economic profit, the firm would only be breaking
even, and no more firm will enter the market because the rate of return is no
better than they can earn elsewhere.
Economic Loss: Is the situation in which a firm's total revenue is less than its
total costs, including implicit costs.
At the lower level of output and lower price, the firm will be suffering an
economic loss, because it would not cover all its costs. As long as the price is
above average cost, the firm will continue to produce in the short run, even

when its suffering losses. But in the long run, firms will exit an industry if they
are unable to cover all their costs.
Economic losses cause firms to exit an industry. The exit of firms forces up the
equilibrium market price until the typical firm is breaking even. This process of
entry and exit results in long run competitive equilibrium. In long run
competitive equilibrium, entry and exit have resulted in the typical firm
breaking even. The long run equilibrium market price is at a level equal to the
minimum point on the typical firm's average total cost curve.
The long run supply curve is the relationship in the long run between market
price and the quantity supplied. In the long run, the price of a product in a
perfectly competitive market will remain constant no matter how many units
are produced.
In the long run, a perfectly competitive market will supply whatever amount of
a good consumers demand at a price determined by the minimum point on the
typical firm's average total cost curve.
Constant-cost Industries are any industries in which the typical firms
average costs do not change as the industry expands production and it will
have a horizontal long run supply curve.
Increasing-Costs Industries are industries with upward-sloping long-run
supply curve.
Decreasing-Costs Industries are industries with downward-sloping long-run
supply curve. The typical firm's costs may fall as the industry expands.
Productive efficiency refers to the situation in which a good or service is
produced at the lowest possible costs. Perfect competition results in productive
efficiency, if a manager of a firm achieves to reduce costs, other firms quickly
copy the ways of reducing costs, so that in the long run, only consumers
benefits from cost reductions.
CHAPTER 9

Monopoly is a firm that is the only seller of a good or service that does not
have
a
close
substitute
A firm has a monopoly if it can ignore the action of other firms.
The barriers of entry are so high that no other firm can enter, this may be for
reasons like:
1. Government blocks the entry of more than one firm in the market

2. One firm has control or power over a key resource needed to produce
the good
3. There are important network externalities in supplying the good or
service
4. Economies of scale are so large that one firm has a natural monopoly

Some markets are blocked by the government for reasons like the patents or
copyright exclusively to an individual firm, giving them the exclusive right to
produce a product. Another reason might be granting a firm a public franchise,
making it the exclusive legal provider of a good or service.
A patent give a firm the exclusive right to a new product for a period of 20
years from the date the product is invented. The government grants patents to
encourage firms to spend money on the research and development necessary
to create new product.
Creators of books, films and software receive a copyright protection which
give them the exclusive right to use the creation during the creator's lifetime
and the creator's heirs retain this exclusive right for 70 years after the creator's
death.
A public franchise allows a firm to be the only provider of a good or service
for example a sole provider of electricity, natural gas or water.
Government may decide to provide certain services directly to consumers
through a public enterprise such as public transportation, metro, etc.
Network externalities refers to the situation where the usefulness of a
product increases with the numbers of consumers who use it. This situation can
set off a virtuous cycle: If a firm can attract enough costumers initially, it can
attract additional customers because its product's value has been increased by
more people using it, which attracts even more consumers.
A Natural Monopoly occurs when economies of scale are so large that one
firm can supply the entire market at a lower average cost than two or more
firms.
Natural monopolies are most likely to occur in markets where fixed costs are
very large relative to variable costs.
Monopoly maximizes profit by producing where marginal revenue equals
marginal costs.
A monopoly's demand curve is the same as the demand curve for the product.
Monopolies are price markers, if it raises its prices it would lose some but not
all of their customers.

The demand curve for monopolies is downward-sloping and the marginal

revenue curve is downward sloping to.

Monopoly
Monopoly
Monopoly
economic

causes a reduction in consumers surplus.

causes an increase in producers surplus.
causes deadweight loss, which represents a reduction in
efficiency.

Market power is the ability of a firm to charge a price greater than the marginal
cost.
Collusion refers to an agreement among firms to charge the same price or
otherwise not to compete. These are regulated with government policies called
the antitrust laws, which make illegal any attempts to form a monopoly or to
collude and promote competition among firms.
Government also regulate firms that are natural monopolies, often by
controlling the prices they charge.
The government also regulates business mergers, because firms gain market
power by merging, they may use that market power to raise prices and reduce
outputs. There are two types of mergers:
1. Horizontal Mergers: A merger between firms in the same industry,
these are more regulated because they are more likely to increase their
market power easily.
2. Vertical Mergers: Are mergers between firms at different stages of the
production of a good.
The government defines the relevant market on the basis of whether there are
close substitutes being made by the merging firms.
Also exists the possibility that the newly merged firm might be more efficient
than the merging firm were individually and allowing these firms to merge
might be good for the firms and consumers, firms could reduce costs and
consumers could get a better quality product.
Market Definition: A market consis of all firms making products that
consumers view as close substitutes, this can be identified by looking at the
effect of a price increase in a product.
Measure of Concentration: A market is concentrared if a relative small
number of firms have a large share of total sales in the market and a merger
between firms in a market that is already highly concentrated is very likely to
increase market power.

Chapter 10

Monopolistically Competitive Markets: A market structure in which barriers

to entry are low and many firms compete by selling similar, but not identical,
products. The demand curve is a downward-sloping function.
However in order to sell more its marginal firms have to cut their prices, so its
marginal revenue curve will slope downward and will be below its demand
curve.
Average revenue is always equal to prices.
Produce where the marginal revenue is equal to marginal cost, and at the same
time when P > MC
The key to ear economic profits is either sell a differentiated product or to find
a way of producing an existing product at a lower cost.
Oligopoly: A market structure in which a small number of interdependent firms
compete. The approach used to analyze competition among oligopolists is
called the game theory, which is used to analyze any situation in which groups
or individuals interact, it is the study of the decisions of firms in industries
where the profit of each firm depend on its interaction with other firms.
A franchise is a business with the legal right to sell a good or service in a
particular area. When a firm uses franchises, local businesspeople are able to
buy and run the store in their area. This makes it easier for a firm to finance its
expansion but forces the firm to give up some control over its stores.
Firms try to avoid losing profits by reducing costs, by improving their products,
or by convincing consumers their products are indeed different from what
competitors offer. To stay one step ahead of its competitors, a firm has to offer
consumers goods or services that they perceive to have greater value than
those offered by competing firms. Value can take the form of production
differentiation that makes the good or service more suited to consumer's
preferences, or it can take the form of a lower price.
Monopolistically competitive firms charge a price greater than marginal cost,
and do not produce at minimum average total cost.
A Business Strategy are the actions taken by a firm to achieve a goal, such
as maximizing profits, the payoffs are the profits earned as a result of a firms
strategies interacting with the strategies of other firms.

A Dominant Strategy is the best strategy for a firm, no matter what

strategies other firms use.
A Nash Equilibrium is a situation in which a firm chooses the best strategy,
given the strategies chosen by other firms.
Cooperate Equilibrium: An equilibrium in a game in which players cooperate
to increase their mutual payoff.
Non-cooperative Equilibrium: An equilibrium in a game in which players do
not cooperate but pursue their own self interest.
Prisoner's dilemma: A game in which pursuing dominant strategies results in
noncooperation that leaves everyone worse off.
Price Leadership: A form of implicit collusion where one firm in an oligopoly
announces a price charge, which is matched by the other firms in the industry.
Cartel: A group of firms that collude by agreeing to restrict output to increase
prices and profits

CHAPTER 12

Macroeconomics is the study of economy as a whole, including topics such as

inflation, unemployment, and economic growth. Economist study factors that
affect markets at the same time.
The Business Cycle refers to the alternating periods of expansion and recession
that the US Economy has experienced since at least the early nineteenth
century.
Expansion is a period during which total production and total employment are
increasing.
Recession is a period during which total production and total employment are
decreasing.
Economic Growth refers to the ability of an economy to produce increasing
quantities of goods and services.
Macroeconomics analyzes both what determines the rate of economic growth
within a country and the reason growth rates differ so greatly across countries.
Inflation Rate, or the percentage increase in the average level of prices from
one year to the next.
Macroeconomic analysis provides information that consumers and firms need in
order to understand current economic conditions and to help predict future
conditions.
Economist measure total production Gross Domestic Product (GDP). GDP is
the market value of all final goods and services produced in a country during a
period of time.

GDP is measured using market values in terms of dollars, not quantities.

GDP includes only the market value of final goods, which are the ones
that are purchased by its final user and is not included in the production
of any other good or service.
An intermediate good or service are the ones that are an input to
another good or service.
GDP includes only current production, which take place during the
indicated time period.

Incomes are divided into four categories: Wages, Interest, Rent and Profit.
Transfer Payments include social Security payments to retired and disabled
people and unemployment insurance payment to unemployed workers.

The sum of wages, interest, rent and profits is the total Income in the
economy. GDP is measures as the total income received by
households.
Imports are foreign produced goods and services.
Banks and stock and bond markets make up the financial system.
Components of GDP

Personal consumption expenditures, are consumptions by households on

services, nondurable goods and durable goods.
Gross private domestic investment, or investments that are divided in
three:
Business fixed investments.
Residential Investments
Changes in business inventories.
Government Consumption and gross investment, or government
purchases, spending by federal, state and local government on goods
and services.
Net exports of goods and services, exports minus imports.

GDP = CONSUMPTION + INVESTMENT + GOVERNMENT PURCHASES+PLUS NET

EXPORTS
GDP does not include two types of production:
1. Household production: goods and services people produce for
themselves.
2. The underground economy: Buying and selling of goods and services
that is concealed from the government to avoid taxes, regulations or
becuase the goods or services are illegal.
GDP per capita: value of real GDP for a country divided by the population.

Value of Leisure is not included in GDP

GDP is not adjusted for pollution or other negative effects of production.
GDP is not adjusted for changes in Crime and Social Problems
GDP measures the size of the pie but not how it is divided.

Nominal GDP: Calculated summing the current values of goods and services.
Real GDP: The value of final goods and services evaluated at base-year prices.
GDP Deflator = ( Nominal GDP / Real GDP ) * 100
Gross national Product GNP : Value of final goods and services produces by
residents of USA, even if the production is outside USA.

Net National Product NNP: Value of product minus depreciation

National Income: The difference between Net National Product sales taxes.
Personal Income: Income received by households
Disposable Personal Income: Personal income minus personal tax
payments.