MICROECONOMIC
DEFINITIONS-PART 3
*STARRED ITEMS WILL BE
CONSIDERED ONLY FOR EXTRA CREDIT DEFINITIONS.
46. ECONOMIC COSTS:
Equals the sum of accounting plus opportunity costs. Accounting costs are all
explicit or tangible costs that can be precisely calculated.
47. TOTAL COSTS (TC):
Total costs or economic costs are composed of both opportunity (implicit) costs
as well as accounting (explicit) costs. TC are SR
costs when they are composed of both fixed and variable costs but LR costs when
they are composed of only variable costs.
48. ECONOMIC PROFITS:
Total revenue minus economic costs or TR - TC. Note that this concept of
profits requires a comparison of how well an entrepreneur is doing with his
current use of resources relative to his next best alternative (the opportunity
cost concept of profits).
49. ACCOUNTING PROFITS:
Total revenue minus accounting costs.
50. CONSTANT-COST
INDUSTRY: An industry for which entry and exit do not cause the costs of firms
already in the industry to change (i.e. to increase or decrease). The LR supply
curve for this industry is perfectly elastic.
51. INCREASING-COST
INDUSTRY: An industry for which entry and exit do cause the costs of firms
already in the industry to change (i.e. entry of new firms will cause the costs
to increase because new entrants must compete with existing firms for one or
more of the fairly specialized resources this industry uses). The LR supply
curve is upward sloping but is more elastic than the SR supply curve.
*52. RENT-SEEKING: The
pursuit and protection of above competitive (or normal) economic profits
through the political process. Rent-seekers will either lobby the legislature
to enact legal entry barriers (to prevent new entry from eroding positive
economic profits) or seek to increase the costs of new entrants by suing them
in court or appealing to a government agency to examine their new technology
(thereby reducing the likelihood of entry). These expenditures are wasteful
insofar as they are directed toward transferring wealth instead of creating it.
Such waste is designated a rent-seeking loss.
53. AGRICULTURAL PRICE
SUPPORTS: The USDA sets a price floor, Psup,
above the equilibrium price for some agricultural commodity.
NOTE
THE FOLLOWING:
(1)
The Commodity Credit Corporation or CCC (which is part of the USDA) makes a
loan to farmers who have signed up for the program for x bushels of wheat at
the Psup. If the farmer subsequently sells
his wheat on the market, he then pays off the loan; if he cannot sell the wheat
on the market, the government will take the wheat and the farmer does not have
to pay off the loan (called a non-recourse loan).
(2)
When market prices rise above Psup, the
farmer can profit from the increased market price.
(3)
Consequently, price supports provide farmers with insurance against market
prices falling below the support level but allow farmers to profit from market
price increases above the support level.
54. PRODUCTION CONTROLS:
Farmers who are eligible to collect price supports must set aside a certain
amount of their land to reduce the amount of surplus commodities that are sold
to the CCC. This provision was enacted because USDA found themselves with
excessive amounts of agricultural commodities in storage.
55. TARGET PRICING
(DIRECT PAYMENTS): USDA sets a target price, PTAR, such that farmers
will produce and sell all of the wheat (or any other commodity) that they have
on hand to consumers for some price PCON where PTAR >
PCON. The government then makes a direct payment to farmers of the
difference between the PTAR and PCON, i.e. (PTAR
- PCON)Q. Note that when market prices
(equilibrium prices) rise above PTAR the direct payment is zero.
NOTE
THE FOLLOWING:
(1)
There are two advantages to the government from such an arrangement: (a) Consumers get lower prices and (b) The
government will not have to cover the costs of storing the surplus commodities.
(2)
The main disadvantage of such an arrangement is the fact that the subsidy to
farmers is more visible.
56. MONOPOLY
(Traditional): A single seller of a good for which there are no close
substitutes.
57. MONOPOLY
(Alternative): A single seller of a good for which there might be close
substitutes. Such a firm can prevent entry both in the SR and the LR by legal
entry barriers. Note that a group of firms acting together to exclude new
entrants by legal means would also be considered a monopoly.
58. AVERAGE REVENUE:
Total revenue divided by output. AR = TR/Q.
59. MARGINAL REVENUE:
The additional revenue earned when output is increased by some small amount. MR
= ΔTR/ΔQ.
60. THE AVERAGE-MARGINAL
PRINCIPLE: When the marginal is above the average, the average is rising; when
the marginal is below the average, the average is falling.
61. PROFIT MAXIMIZATION
RULE: Firms achieve maximum profits when they set MR = MC. This rule is
supplemented by two corollaries: (a) when MR > MC expand
output in order to increase profits, and (b) when MR < MC contract output in
order to increase profits.
62. LONG-RUN AVERAGE
COSTS: LRAC = TC/Q. Total costs (LR) divided by output.
63. LONG-RUN MARGINAL
COSTS (LRMC): The additional total cost that occurs when one more unit of
output (Q) is produced. Note that MC = ΔTC/Δ Q.
64. PRICE-SEARCHER: A
firm which is large enough relative to the market so that it can choose the
price on the demand curve that its consumers must pay for the product (i.e. the
firm has some market power which implies that it faces a downward-sloping
demand curve). A price-searcher is different from a monopoly in one important
respect: it cannot bar new entry either in the SR or the LR.
*65. INEFFICIENCY OF
MONOPOLIES: These firms will produce where MR=MC (i.e., they will maximize
their profits) and will have positive economic profits because of legal entry
barriers which is inefficient. This inefficiency means that resources are
misallocated; that is, these monopolies tend to use too little resources while
extra resources are diverted into other sectors of the economy where they are of
lesser value.
66. EFFICIENCY OF PRICE
SEARCHERS: These firms will produce where MR=MC (i.e., they will maximize their
profits) and will have zero economic profits because there are no legal entry
barriers.
NOTE
THE FOLLOWING:
(1) Price-searchers are inefficient when economic profits are positive but this inefficiency is eliminated by the eventual entry of competitors.