Questions

Consumer theory

  • Define an indifference curve. What are the 3 properties of indifference curves?

An indifference curve corresponds to the set of bundle of good x and y that provides the same level of utility. Each indifference curve represent a different level of utility. Indifference curves are characterized by 3 properties: IC are downward sloping (non satiety), two IC cannot cross (transitivity assumption), IC are convex (preference for diversity). The latter property does not hold for very specific goods: addictive ones.

Producer theory

  • What is the relationship between the long and the short run cost curves?

Long run costs give us the lowest cost of producing a given quantity when all factors of production are variable, whereas short run costs give us the lowest cost of producing a given quantity when some factors are fixed. Long run costs can never be higher than short run costs and the two cost curves coincide when the fixed factor underlying a short run cost curve is in the optimum amount for that quantity.

See this video for a complete explanation

  • What is the difference between economies of scale and return to scale?

Economies of scale refer to the way our costs vary with the quantity produced. We have economies of scale if average costs are decreasing with the quantity.

Returns to scale refer to the increase in output when we increase all factors of production by the same proportion. If output increases by a higher proportion than the inputs, we have increasing returns to scale, if it increases by the same proportion we have constant returns to scale, and if it increases by a smaller proportion, we have decreasing returns to scale.

“Economies of scale” refers to a key implication of increasing returns to scale: the average cost of production declines as the scale of production increases. It is thus more efficient to produce on a large scale.

Competitive markets

  • How is the individual profit of firms in the long run?

In the long run, loss-making firms will exit (freely) the market. Meanwhile, profit-making firms enter the market as long as there are economic profits to be made, i.e. as long as price exceeds the average total cost. Entry of new profit-making firms shift supply to the right and price decreases until firms make no profit (no more entry or exit).

Monopoly

  • What are the main characteristics of a monopolistic market?

In a monopoly there is a single firm operating and supplying all the quantity in a given market. The monopolist can chose any price quantity pair along the demand curve: we say that the monopolist is "price maker". There is no free entry and no close substitutes that can affect the demand aimed at the monopolist, so it is able to charge prices above the marginal and average cost and consistently obtain positive profits.