Sunk Costs; Sunk Costs and Profit-Maximization

Topics for Final Exam

Opportunity cost

• sum of implicit and explicit cost

Sunk costs; sunk costs and profit-maximization

• Profit maximization - the assumption that firms select an output level so as to maximize profit.

Supply and demand shifts, impacts on the equilibrium price and equilibrium quantity

• an increase in demand from D to D' with supply unchanged leads to a higher equilibrium price and output.
• an increase in supply from S to S' with demand unchanged leads to lower equilibrium price and higher equilibrium output.

The impact of price changes on total revenue: the role of the price elasticity of demand (Chapter 2)

• Price elasticity of demand - a measure of how sensitive quantity demanded is to a change in a product's price.
• The price elasticity of demand tells us what happens to total revenue when prices - its size determine which effect - the price effect or the quantity effect - is stronger.

Factors affecting the price elasticity of demand ( Chapter 2)

• When price elasticity exceeds unity, demand is elastic, and a lower price expands purchases so sharply that total expenditure.
• When price elasticity is less than unity, demand is inelastic, and lower price leads to reduction in total expenditure.
• When price elasticity equals unity, demand is unit elastic and total expenditure is unchanged at a lower price.
• other three elasticities are

• Income elasticity of demand -  measure of how responsive consumption of some item is to a change in income assuming the price of the good itself remains unchanged.
• Cross-price elasticity of demand - measure of how responsive consumption of one good is to a change in the price of a related good.
• Price elasticity of supply - measure of responsiveness of quantity supplied of a commodity to a change in the commodity's own price.

Factors causing increasing returns to scale, decreasing returns to scale (chapter 7)

• Increasing return of scale - a situation in which output increases in greater proportion than input use. ( not dollar or cent)
• Decreasing return of scale - a situation in which output increases less than proportionally to input use.

Relationship between returns to scale, economies of scale, and the shape of the long-run average total cost curve ( Chapter 7) & ( Chapter 8)

• Economics of scale - a situation in which a firm can increase its output more than proportionally to its total input cost
• Long-run average total cost curve - is heavy scalloped portion of five SAC curves. As the number of possible scales of plant increases, the long-run average cost curve becomes the  smooth U-shaped LAC curve.

Relationship between the marginal cost curve, the average variable cost curve, the         average fixed cost curve, and the average total cost curve (chapter 8)

• Marginal Cost - it is U-shaped with the cost of additional units of output first falling, reaching minimum and the rising.
• Avg. variable cost curve - is equal to TVC divided by output.
• TVC, AVC and MC are always equal to each other
• Avg. fixed cost curve - total fixed cost divided by the amount of output
• Avg. total cost curve -  total cost divided by output

Conditions for perfect competition ( chapter 9)

1. Large numbers of buyers and sellers
2. Free entry and exit
3. Product homogeneity
4. Prefect information

Demand curve facing one firm under perfect competition vs. the overall market demand curve. Figure 9.1 

Production level (for one firm) under perfect competition that will maximize profits

• For any firm, the most profitable output occurs where the MC of producing another unit of output just equals the MR from selling it.

Short-run shutdown decisions if losses are unavoidable

• The minimum level of AVC below which the firm will cease operations

“Economic” profits or losses vs. accounting profits or losses; impact on long-run entry or exit decisions and market supply