ECN5050 Review Questions Exam 2

1. Returns to Scale is a production concept while

Economies of Scale is a cost concept. Using an example illustrate how the two are related. The two concepts are related because returns of scale measures the increase in input and its affect on output summarized as constant returns of scale, increasing returns to scale, and decreasing returns to scale. An economy of scale is cost analysis of how the production of each output corresponds to increasing returns to sale versus total cost (economies of scale) for example: Lets say, I am the owner of Bakery that produces Jamaican patties for my local community; the most important variable in my Jamaican Patties are ground beef and the most expensive based on the national average @ $3.87. The meat content in each patties is never the same but the cost remains fixed and depending on the workers abilities, patties can be a minimum 10 (5lbs of ground beef) and a maximum of 30 (10lbs of ground beef)

Input

Output

Input Cost (TC) $19.35 $38.70 $19.35 $38.70 $19.35 $38.70

for a pound of ground beef is $3.87 used from : http://money.cnn.com/2011/03/31/markets/beef_price_increa sing/index.htm The illustration in green provides a glimpse of economies of scale and increased sales while reducing cost per item.

5 lbs 10 ground Patties Beef 10 lbs 25 ground Patties beef 5 lbs 10 ground Patties Beef 10 lbs 30 ground Patties beef 5 lbs 10 ground Patties Beef 10 lbs 12 ground Patties beef The average price

Average Total cost/ Impact total cost Quantity of input change output $19.35/1 $1.935 Constant 0 Returns to Scale $38.70/2 $1.548 5 $19.35/1 0 $38.70/3 0 $19.35/1 0 $38.70/1 2 $1.935 $1.29 $1.935 $3.225 Increasi ng Returns to Scale Decreasi ng Returns to Scale

2. What is the goal of a firm? In my opinion, the goal of any firm is earning economic and account profits through profit maximization strategies; sustaining an input while producing an increased output at a reduced average total cost increases quantities sold, thus increases sales revenue and net earnings. 3. What do we mean by the term normal profit? Economic profits equal zero. More specifically, total revenue total cost (explicit and implicit) equals zero. Opportunity cost is taken in consideration; it is the minimum level of profit required to be competitive 4. What do we mean by the terms economic profit and economic loss? Economic profits takes in consideration fixed cost +variable cost + opportunity cost total revenue; profits are established if the total revenue exceeds the fixed cost, variable cost, and opportunity cost Economic Loss is experience when fixed cost + variable cost + opportunity cost exceeds total revenue 5. Using an illustration explain how a firm might be: Jamroc Bakery, a real family own small business, has fixed and variable cost of $85,000.00 and total revenue of $150,000.00. Mr. Hoo has placed $25,000.00 to start the business and can earn up $35,000.00 (Max) as baker at Publix supermarket. His profits or losses are as followed: Economic Profit Rev $150k-$85k (Fixed and Variable Cost)-$25 (funds from savings) -$35k (salary) = 5k in economic profits

o Although there is an economic profit of $5k, it is

unrealistic to see how anyone with an opportunity to bring 35k working for Publix would open a business to net in economic profits of 5k without including tax and other income reducers. In this example the accounting profit is $150k (total revenue) - $85k (Fixed and variable cost) = 65k Rev $150k-$85k (Fixed and Variable Cost)-$25 (funds from savings) -$35k (salary) = 5k in economic profits

For Mr. Hoo to earn an accounting profit and zero economic profit the following factors are required: Zero Economic profits Accounting profits are $150k (Total revenue) - $85k (fixed and variable cost) = 65k accounting profits Zero Economic profit would include: Rev $150k -85k (fixed and variable cost) -$30k (funds from savings) - $35k (salary) = zero economic profits o Mr. Hoo could work for Publix making 35K per year and save his investment (if possible) of 25K into Jamroc Baker, instead of opening a business and actually making zero economic profits. Thus, closing the business would decrease the amount of bakeries in the area at the give explicit and implicit cost. Nothing to gained to enter to market. An economic loss would include an increase in salary earned for bakers from $35k to 50K and sustained investment from savings (25K), which would be displayed as followed: Economic Loss Accounting profits are $150k (Total revenue) - $85k (fixed and variable cost) = 65k accounting profits Rev $150k -85k (fixed and variable cost) -$30k (funds from savings) - $50k (salary) = -15k in economic loss

o Mr. Hoo could work for Publix making 50K per year and save his investment (if possible) of 25K into Jamroc Baker, instead of opening a business and actually making zero economic loss. Thus, closing the business would decrease the amount of bakeries in the area at the give explicit and implicit cost. Working at the Publix would be the intelligent decision for an existing owner and an additional bakers seeking to enter the bakery business. $35k in salary was used from the National Culinary guide @ http://www.culinaryschoolguide.org/baking-pastryarts/average-salary-of-a-baker-or-pastry-chef/

6. Describe the varies types of barriers to entry.

(Chapter 12) Barriers are created by governments and include licenses and exclusive franchises, which affect various industries. Patent laws also can, but need not, create strong barriers to entry. Essential input barriers.. A firm controls raw materials supplies and dictate an unfair market price for raw materials for competitors to compete. Brand loyalties. Strong customer loyalty restricts new firms from entering a saturated market where buyers fixated on one organization to purchase their product. Example Coca-Cola and Microsoft Consumer lock-in.

The essential cost for customers to switch form one product to another because the quality and superiority; for example Apple is the worlds admired corporation with its IPAD devices and Iphones; another organization may believe that its costly for customer with contracts with ATT and Verizon to cancel their contracts and switch to a new service provider and product. Network externalities. Organizations such ATT and Verizon had enormous telecommunication towers, wireless spectrum, and data capacity that could bar new firms from entering due to the cost associated with using external towers. Metro PCS experienced this with its CDMA technology, the service provider paid additional fees to use external spectrum to supply there customer with service, thus increasing expense per output. Since ATT, Verizon, and Sprint occupy 95% of the national wireless spectrum and household services, it would be difficult for an organization to enter the wireless industry. Economies of scale. When long-run average cost declines over a wide range of output relative to the demand for the product, there may not be room in the market for another large producer to enter the marketat least not without driving price below unit costs making it unprofitable to enter.
7. What is price discrimination? Under what conditions

might it occur?

Price discrimination is the existence of price manipulation for the same product to different customer or consumers. Price discrimination is allowed to happen because the organization making the price may be the market maker or have input barriers and the demand for the

input is vast. It provides the opportunity for additional profits to collect based on demand. For example, when a new game console is released, the retail stores have limited quantities; individual buyers are able to buy several console and resale each item on Ebay for various prices based on the demand and the willing to have the product.

8.

Illustrate, and explain what will happen, when a monopolist: a. earns an excess economic profit a. If and when there is excess economic profits, new firms will enter in the short run; over the long haul or period of time larger firms may enter the market if excess profit remains. Total revenue must be greater than total cost. b. b. b. b. b. b. b. b. b. b. b. b. b. b.

a. Earns an economic loss i. The firm will remain in operation only if P> AVC. If P < AVC the firm will not be covering its variable costs and will shut down. Total cost must be greater than total revenue. TC > TR

9. What is monopolistic competition? In what three areas

do these firms compete? Price-setters selling similar products or substitutes differencing only by branding; low barriers to entry are prevalent where an imperfect competition exist. Competition involves price, marketing, and product quality.

10. Explain the rationale underlying the kinked demand

curve. Relative price elastic and relative price inelastic sections explaining the relationship of how an Oligopoly competes on the basis of price and non-price competition. Due to the type of competition, marginal cost is normally set to marginal revenue (more products sold, the lower the price must be, equals less a producer can earn). Raising price could lose the customer base or engage in a price war with competitors. Firm large firms