Session 4 Economics Summary

Intro to Macroeconomics, National Output and National Income, and Macroeconomic Concerns Introduction

Macroeconomics is a part of our everyday lives. If the macroeconomy is doing well, few people do not have jobs who want one, people’s incomes are generally rising, and profits of corporations are generally high.

Macroeconomics focuses on the determinants of total national output, whereas microeconomics focuses on the factors that influence the production of particular products and the behavior of individual industries. Macroeconomics is concerned with the sum or aggregate of industries’ performance, including the consumption of all households in the economy, the amount of labor supplied and demanded by all individuals and firms, and the total amount of all goods and services produced.

Introduction to Macroeconomics
Macroeconomics was born out of the effort to explain the Great Depression of the 1930’s. Since that time, the discipline has evolved, concerning itself with new issues as the problems facing the economy have changed. Through the late 1960’s, it was believed that government could “fine-tune” the economy to keep it running on an even keel at all times. The poor economic performance of the 1970’s however, showed that fine-tuning does not always work.

There are three very important macroeconomic concerns. These include:
Inflation, an increase in the overall price level
Output growth, the short-term ups and downs in the economy
Unemployment, which is the percent of the labor force that is unemployed

Macroeconomics is concerned with both long-run trends and with short-run fluctuations in economic performance. Since 1970, the U.S. has seen three recessions and large fluctuations in the rate of inflation.

National Output and National IncomeGross Domestic Product (GDP) is the key concept in the national income and product accounts. It is the total market value of a country’s output, the market value of all final goods and services produced within a given period of time by factors of production located within a country.

Calculating GDP can be achieved in two ways:
by adding up the amount spent on all final goods during a given period (the expenditure approach), or
by adding up all the income received by all factors of production in producing final goods (the income approach). Either way, we should obtain the same total output.

There are other useful concepts besides GDP. They are:

• Gross National Product (GNP), GDP plus factor income earned by U.S. citizens from the rest of the world and subtracting factor income earned in the U.S. by foreigners
• NNP or Net National Product , which is GNP less depreciation
• National Income (NI), which is NNP less indirect business taxes plus subsidies
• Personal Income (PI), which is the total income of households, and is found by taking NI and subtracting corporate profits minus dividends and social insurance payments, and then adding personal interest income from the government and consumers and transfer payments made to persons
• Disposable Personal Income, which is PI after personal income taxes are paid
• Nominal GDP is GDP measured in current dollars, or the current prices we pay for things. This is not a desirable measure of production, because production could seem to increase when in fact only the price has increased. Calculating real GDP means using a geometric average over two base years and changing the base years used as the calculations move through time.

Serious problems arise when we try to use GDP as a measure of happiness or well-being. For example:

• Some changes in social welfare are not measured by GDP
• There is an underground economy that should be counted in GDP but is not, due to the fact that they are considered illegal activities or a result of tax evasion
• Per Capita GDP or GNP, which is divided by a country’s population, is a better measure of well-being for the average person than is total GDP or GNP
  

Macroeconomic Concerns
An ideal economy is one in which there is rapid growth of output per worker, low unemployment, and low inflation. There can be times of slow growth, however—high unemployment and high inflation.

Several macroeconomic concerns include:
A recession, which is a period where real GDP declines for at least two consecutive quarters
A depression, which is a prolonged and deep recession
Unemployment, which is the ratio of the number of unemployed people to the number of people in the labor force

One final macroeconomic concern is inflation. Inflation is an increase in the overall price level. It happens when many prices increase simultaneously. A deflation is a decrease in the overall price level. Whether a person gains or loses during a period of inflation depends on whether his or her income rises faster or slower than the prices of the things he or she buys.

Economics Chapter 22

why do economies grow?

Capital deepening -- increases in the stock of capital per worker
technological progress -- an increase in output without increasing imports
human capital -- the knowledge and skills acquired by a worker through education and experience and used to produce goods and services
real GDP per capita -- gross domestic product per person adjusted for changes in prices. It is the usual measure of living standards across time and between countries
growth rate -- the percentage rate of change of a variable
rule of 70 -- a rule of thumb that says the output will double in 70/x years where x is the percentage rate of growth
convergence -- the process by which poor countries "catch up" with richer countries in terms of real GDP per capita
saving -- total income minus consumption
growth accounting -- a method to determine the contribution to economic growth from increased capital, labor, and technological progress
labor productivity -- output produced per hour of work
creative destruction -- the process by which competition for monopoly profits lead to technological progress
new growth theory -- modern periods of growth that try to explain the origins of technological progress

Notes

Economic do not have a complete understanding of what leads to growth, they regard increases in capital per worker, technological progress, human capital, and governmental institutions as key factors.

There are vast differences in per capita GDP throughout the world. There is debate about whether poorer countries in the world are converging in per capita incomes to richer countries.

Economy's growth through two basic mechanisms:
capital deepening and technology all processes.

Capital deepening is an increase in capital per worker. Technological progress is an increase in output with no additional increases in inputs.

Ongoing technological progress will lead to sustained economic growth.

A variety of theories try to explain the origins of technological progress and determine how we can promote it.
They include
spending on research and development,
creative destruction,
the scale of the market,
induced inventions,
education, and
the accumulation of knowledge.

Governments can play a key role in designing institutions that promote economic growth.
Investments in human capital are a key component of economic growth.

Economics Chapter 21

the economy at full employment

Classical model -- models assume wages and prices adjust freely to changes in demand and supply
production function -- the relationship between the level of output and the factors of production
stock and capital -- a total of all the machines, equipment, and buildings in the entire economy
labor -- human effort, including both physical and mental effort, used to produce goods and services.
Real wage -- the wage paid to workers adjusted for changes in prices
substitution effect -- an increase in the wage will raise the opportunity cost of leisure and lead to an increase in hours worked
income effect -- as income rises, a worker may choose to work fewer hours in enjoyed more leisure
full employment output -- the level of output that results when the economy is producing at full employment
real business cycle theory -- the economic theory that emphasizes how shocks to technology can cause fluctuations in economic activity
crowding out -- the reduction in investment in the long run caused by an increase in government spending
closed economy -- an economy without international trade
open economy -- an economy with international trade
crowding in -- the increase of investment in the long run caused by decrease in government spending

Notes

Full employment or potential output is the level of GDP produced from a given supply of capital when the labor market is in equilibrium. Potential output is fully determined by the supply of factors of production in the economy.

Increases in the stock of capital raise the level of full employment output and real wages.
Increases in the supply of labor will raise the level of full employment output but lower the level of real wages.

The full employment model has many applications. Many economists use it to study the effects of taxes on potential output. Others have found it useful in understanding economic fluctuations.
At full employment, increases in government spending less come at the expense of other components of GDP. In a closed economy, either consumption or investment must be crowded out. In an open economy, net exports can be crowded out as well. Decreases in government spending will crowd and other types of spending.

Economics Chapter 20

unemployment and inflation

Unemployed -- people who are looking for work but do not have jobs
employed -- people with jobs
labor force -- the employed plus the unemployed that are looking
unemployment rate -- a fraction of the labor force that is unemployed
labor force participation rate -- the fraction of the population over 16 years of age that is in the labor force
discouraged workers -- workers who left the labor force because they could not find jobs
marginally attached workers -- individuals who have worked in the past to stop working for a variety of reasons
seasonal unemployment -- the component of unemployment attributed to seasonal factors
cyclical unemployment -- the component of unemployment that accompanies fluctuations in real GDP
fractional unemployment -- the part of unemployment associated with the normal workings of the economy, such as searching for jobs
structural unemployment -- a component of unemployment reflecting a mismatch of skills and jobs
full employment -- the level of employment that occurs when the unemployment rate is that the natural rate
unemployment insurance -- payments received from the government upon becoming unemployed
consumer Price Index (CPI) -- a price index that measures the cost of a fixed basket of goods chosen to represent the consumption pattern of individuals
cost-of-living adjustment (COLAs) -- automatic increases in wages or other payments that are tied to a price index
inflation rate -- the percentage rate of change in the price level
deflation -- negative inflation or falling prices
menu costs -- costs of inflation that arise from actually changing prices
shoe-leather costs -- costs of inflation that arise from trying to reduce holdings of cash
hyperinflation -- an inflation rate exceeding 50% per month

Notes

The unemployed are individuals who did not have jobs or actively seeking employment.

Seasonal, cyclical, fractional, and structural are all different types of our employment.

Unemployment rates vary across groups. Alternative measures of unemployment take into account individuals who would like to work full-time, but wore no longer in the labor force or are holding part-time jobs.

Economists measure change in the cost of living through the Consumer Price Index, which is based on the cost of purchasing a standard basket of goods and services.

We measure inflation as the percentage change in the price level.

Economists believe that most price indices overstate true inflation because they failed to capture quality improvements.

Unemployment imposes both financial and psychological costs on workers.
Both anticipated an unanticipated inflation impose costs on society.

Economics Chapter 19

measuring a nation's production and income

Macroeconomics -- the branch of economics that looks at a nation's economy as a whole
recession -- commonly defined as six consecutive months of negative economic growth
inflation -- sustained increases in prices
factor markets -- the markets in which labor and capital are traded
product markets -- the markets in which goods and services are traded
Gross domestic product (GDP) -- the total market value of all the final goods and services produced within an economy in a given year
intermediate goods -- goods used in the production process that are not final goods or services
real GDP -- a measure of GDP that controls the changes in prices
nominal GDP -- the value of GDP in current dollars
economic growth -- sustained increases in the real production of an economy over a period of time
consumption expenditures -- purchases of newly produced goods and services by households
durable goods -- goods that last for a long period of time, such as household appliances
nondurable goods -- good to last for short periods of time, such as food
services -- reflect work done in which people play a prominent role in delivery, ranging from here cutting to health care
private investment expenditures -- purchases of newly produced goods and services by firms
Gross investment -- actual investment purchases
depreciation -- the wear and tear of capital as it is used in production
net investment -- Gross investment minus depreciation
government purchases -- purchases of newly produced goods and services by all levels of government
transfer payments -- payments to individuals from governments that do not correspond to the production of goods and services
imports -- a good produced in a foreign country and purchased by residents of the home country
exports -- it's produced in the home country and sold in another country
net exports -- exports minus imports
trade deficit -- the excess of imports over exports
trade surplus -- the excess of exports over imports
national income -- net national product less indirect taxes
Gross national product (GNP) -- GDP plus net income earned abroad
net national product (NNP) -- GNP less depreciation
indirect taxes -- sales and excise taxes
personal income -- income received by households
personal disposable income -- personal income after taxes
value added -- the sum of all the income generated by an organization
GDP deflator -- an index that measures how the price of goods included in the GDP changes over time
chain index -- a method for calculating changes in prices that uses base years from neighboring years
Peak -- the time at which a recession begins
trough -- the time at which I'll put stops falling in a recession
expansion -- the period after a trough in the business cycle during which the economy recovers
Depression -- the common name for a severe recession

Notes

Developing meaningful statistics for entire economy is difficult. Statistics can convey useful information if they are used with care.

The circular flow shows how the production of goods and services generate income for households and how households purchased goods and services by firms.

GDP is the market value of all final goods and services produced in a given year.

GDP consists of four components:
consumption
investment
government purchases
net exports.

National income is obtained from GDP by adding net income US individuals and firms are earned from abroad, then subtracting depreciation and indirect taxes.

Real GDP is calculated by using constant prices. The Commerce Department now uses methods that take an average using base years from neighboring years.

A recession is commonly defined as a six-month consecutive period of negative growth. However, in the United States, the National Bureau of Economic Research uses a broader definition.

GDP does not include nonmarket transactions, leisure time, the underground economy, or changes to the environment.

Session 3 Economics Summary

Monopolistic and Oligopolistic Competition

Introduction A number of assumptions underlie the logic of pure competition: (1) a large number of firms and household are interacting in each market; (2) firms in a given market produce undifferentiated, or homogeneous, products; and (3) new firms are free to enter industries and to compete for profits. The first two imply that firms have no control over input prices or output prices; the third implies that opportunities for positive profit are eliminated in the long run. Monopoly A market in which individual firms have some control over price is imperfectly competitive. Three forms of imperfect competition are monopoly, oligopoly, and monopolistic competition. A pure monopoly is an industry with a single firm that produces a product for which there are no close substitutes, and in which there are significant barriers to entry. For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it. The marginal revenue is not equal to product price, as it is in competition. Instead, marginal revenue is lower than price because to raise output one unit and to be able to sell that one unit, the firm must lower the price it charges to all buyers. Compared with a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits. Monopolists will always charge a price higher than marginal cost (the price that would be set by perfect competition), because marginal revenue always lies below the demand curve for a monopoly. Monopolistic Competition and Oligopoly A monopolistically competitive industry has the following structural characteristics: (1) a large number of firms, (2) no barriers to entry, and (3) product differentiation. Relatively good substitutes for a monopolistic competitor’s products are available. Monopolistic competitors try to achieve a degree of market power by differentiating their products. An oligopoly is an industry dominated by a few firms that, by virtue of their individual size

Economics Chapter 16

market structure and public policy

Average cost pricing policy -- a regulatory policy under which the government picks the point on the demand curve at which price equals average cost
trust -- an arrangement under which the owners of several companies transfer their decision-making powers to a small group of trustees, who then make decisions for all the firms
merger -- a process in which two or more firms combine operations
tie-in sales -- a business practice under which a consumer of one product is required to purchase another product
predatory pricing -- a pricing scheme under which a firm decreases its price to drive a rival outs of business and increase the price when the other firm disappears

Notes

In the case of natural monopoly, the government can regulate prices. In other industries, the government uses antitrust policies to affect the number of firms in the market, encouraging competition that leads to lower prices.

A natural monopoly occurs when they are our large scale a common use in production, said the market can support only one firm.

Under an average cost pricing policy, the regulated price for a natural monopoly is equal to the average cost of production.

The government uses antitrust policy to break up some dominant firms, prevent some corporate mergers, and regulate business practices that reduce competition.

The modern approach to merger policy uses price data to predict the effects of a merger.

In most circumstances, predatory pricing is on profitable because the monopoly power is costly to acquire and hard to maintain.

The deregulation of the airline industry led to more competition and lower prices on average, the higher prices in some markets.

Economics Chapter 15

oligopoly and strategic behavior

Oligopoly -- a market served by a few firms
game theory -- a framework to explore the actions and reactions of interdependent decision-makers
concentration ratio -- a measure of the degree of concentration in a market; the four firm concentration ratio is the percentage of the market output produced by the four largest firms
duopoly -- a market with two firms
cartel -- a group of firms that collude explicity, coordinating their pricing decisions
price-fixing -- under arrangement in which two firms coordinate their pricing decisions
game tree -- a geographical representation of the consequences of different strategies
dominant strategy -- an action that is the best choice for a player, no matter what the opponent does
duopolosts' dilemma -- a situation in which both firms in a market would be better off if both shows the high price but each chooses the low-price
simultaneous decision-making game -- a game in which each player makes a choice without the other person knowing what that choice is
sequential decision making game -- a game in which one player makes the choice before the other
guaranteed price matching strategy -- a strategy where a firm guarantees it will match a lower price by a competitor; also known as the meet the competition policy
grim-trigger strategy -- a strategy where a firm response to underpricing by choosing a price so low that each firm makes zero economic profit
tit-for-tat -- a strategy where one firm chooses whatever price the other for chose in the proceeding.
Price leadership -- implicit agreement under which firms and a market chose a price leader, observed that firms price, and match it
kinked demand curve model -- a model under which firms and an oligopoly match price reductions by other firms but do not match price increases by other firms
limit pricing -- a scheme under which a monopolist accepts a price below the normal monopoly price to detour other firms from entering the market
contestable market -- a market in which the costs of entering and leaving are low, so firms that are already in the market are constantly threatened by the entry of new firms
Nash equilibrium -- an outcome of a game in which each player is doing the best here she can, given the action of the other players

Notes

Firms may use cartel pricing or price-fixing to avoid competition and keep prices high. If another firm threatens to enter a monopolist's market, the monopolist may cut its price to discourage other firms from entering a market.

Each firm in an oligopoly pass under incentive to underpriced the other firms, so price-fixing (also known as cartel pricing) will be on successful unless firms have some way of enforcing a fixed pricing agreement.

One way to maintain price-fixing is a guaranteed price matching scheme: one firm chooses the high price and promises to match a lower price offered by its competitor.

Price-fixing is more likely to occur if firms choose prices repeatedly and can punish a firm that chooses a price below the cartel price.

To prevent a second firm from entering the market, an insecure monopolist may commit itself to producing a relatively large quantity and excepting a relatively low price.

Economics Chapter 14

market entry and monopolistic petition

Monopolistic competition -- a market served by many firms selling slightly different products
product differentiation -- a strategy monopolistic firms used to distinguish their products from their competitors

In a monopolistically competitive market, entry continues into each firm and the market makes zero economic profit. Firms can differentiate their products by picking a distinct physical design, level of service, location, or product or aura.

As firms enter a market, the market price drops and the average cost of production increases because each firm produces less output over which to spread its fixed costs.

In a monopolistically competitive market, firms compete for customers by producing differentiated products.

And the long-run equilibrium with monopolistic competition, price equals average cost and economic profit is zero.

Economics Chapter 13

Monopoly and price discrimination

Monopoly -- a market in which a single firm serves the entire market
market power -- the ability to affect the price of a product
patent -- the exclusive right to sell a particular good for some period of time
natural monopoly -- a market in which the economies of scale are so large that only a single large firm can survive
deadweight loss from monopoly -- a measure of the inefficiency from monopolies; with a constant cost industry, equal to the difference between the consumer surplus lost from monopoly pricing and the monopolies profit
rent seeking -- the process of using governments to obtain economic profit
Price discrimination -- the process under which a firm divides consumers into two or more groups and picks a different price for each group

Notes

Compared to a perfectly competitive market, a monopoly means a higher price, a smaller quantity, and resources wasted when firms seek monopoly power. On the positive side, some of the products we use today might never have been invented without the patent system and the monopoly power it grants. Firms with market power often use prices donation to increase their profits.

Compared to a purposely competitive market, a market served by monopolist will have a higher price, smaller quantity of output, and a deadweight loss to society.

Some firms spend money and use resources to acquire monopoly power, a process known as rent seeking.

Patents protect innovators from competition, leading to higher prices for new products but greater incentives to develop new products.

To engage in price discrimination, the firm divides its customers into two or more groups and charges lower prices two groups with more elastic demand.

Price discrimination is not an act of generosity; it's an act of profit maximization.

Section 2 Economics Overview

The Price System, Supply and Demand, Household Behavior and Consumer Choice, General Equilibrium

Every society has a system of institutions that determines what is produced, how it is produced, and who gets what produced. In some societies, these decisions are made centrally, through planning agencies or by government directive. In every society, however, many decisions are made in a decentralized way, through the operation of markets.

The Price System, Supply, Demand
The market system or price system performs two important and closely related functions:

• it distributes goods and services when the quantity demanded exceeds the quantity supplied (known as price rationing), and
• it determines the allocation of resources among producers, and hence the final mix of outputs.

Elasticity is a general measure of responsiveness that can be used to quantify many different relationships. Price elasticity of demand is the ratio of the percentage change in quantity demanded of a good to the percentage change in price of that good.

There are several types of elastic demand:

• Perfectly inelastic, whose quantity demanded does not respond at all to changes in price
• Inelastic demand, whose quantity demanded responds somewhat to changes in price
• Elastic demand, for which the percentage change in quantity demanded is larger in absolute value than the percentage change in price
• Unitary elasticity of demand, for which the percentage change in the quantity of a product demanded is the same as the percentage change in price
• Perfectly elastic demand, for which a small increase in the price of a product causes the quantity demanded for that product to drop to zero

Household Behavior and Consumer Choice
Every household must make three basic decisions:
(1) how much of each product to demand;
(2) how much labor to supply; and
(3) how much to spend today and how much to save for the future.

Within the constraints of prices, income, and wealth, household decisions ultimately depend on preferences: likes, dislikes, and tastes.

Whether one item is preferable to another depends on how much utility, or satisfaction, it yields relative to its alternative. The law of diminishing utility states that the more of any good we consume in a given period of time, the less satisfaction, or utility we get out of each additional unit of that good.

In addition to deciding how to allocate its present income among goods and services, a household may also decide to save or borrow. A household is using current income to finance future spending when it decides to save part of its current income. A household finances current purchases with future income when it borrows.

General Equilibrium and Efficiency
A general equilibrium exists when all markets in an economy are in simultaneous equilibrium. An event that disturbs the equilibrium in one market may disturb the equilibrium in many other markets as well. Partial equilibrium analysis can be misleading, because it looks only at adjustments in one isolated market.

An efficient economy is one that produces the goods and services that people want at least possible cost. A change is said to be efficient if it improves some members of society without worsening others. An efficient (or Pareto optimal) system is one in which no such changes are possible.

Perfectly competitive firms will produce as long as the price of their product is greater than the marginal cost of production; therefore, they will continue to produce as long as a gain for society is possible. The market thus guarantees that the right things are produced. In other words, the perfectly competitive system produces what people want.

Market efficiency depends on the assumption that buyers have perfect information about product quality and price, and that firms have perfect information regarding input quality and price. Imperfect information can lead to wrong choices and inefficiency.

Economics Chapter 12

perfect competition

Perfectly competitive market -- a market with hundreds or thousands of sellers and buyers of a standardized good. Each buyer and seller takes the market price as given. Firms can easily enter or exit the market
firm specific demand curve -- a curve showing the relationship between the price charged of a specific firm and a quantity that can be sold by that firm
economic profit -- total revenue minus total economic cost
total revenue -- the money the firm gets by selling its product; equal to the price times the quantity sold
accounting profit -- total revenue minus explicit costs
marginal revenue -- the change in total revenue that results from selling one more unit of output
breakeven price -- the price at which the economic profit is zero; price equals average total cost
shutdown price -- the price at which the firm is indifferent between operating in shutting down; equal to the minimum average variable cost
sunk cost -- a cost a firm has already paid or has agreed to pay sometime in the future
firms short run supply curve -- a curve showing the relationship between the price of a product and the quantity of output supplied by affirming the short run
short run market supply curve -- a curve showing the relationship between price and quantity supplied in the short run
long run market supply curve -- a curve showing the relationship between the market price and quantity supplied in the long run
increasing cost industry -- an industry in which the average cost of production increases as the total output of the industry increases; the long run supply curve is positively sloped
constant cost industry -- an industry in which the average cost of production is constant; the long run supply curve is horizontal

Notes

In the short run, a firm uses the marginal principle to decide how much output to produce. In the long run, a firm will enter a market if the price exceeds the average cost of production.
A price taking firm should produce the quantity of output at which the marginal revenue (the price) equals the marginal cost of production.

At unprofitable firms should continue to operate if its total revenue exceeds the total durable cost.

The long run supply curve will be positively sloped if the average cost of production increases as the industry grows.

The long run supply curve is flatter than the short run supply curve because there are diminishing returns in the short run, but not in the long run.

An increase in demand causes a large upward jump in price, followed by a downward slide to the new long-run equilibrium price.

Economics Chapter 11

production technology and cost

Economic cost -- the opportunity cost of production, including both explicit and implicit costs
explicit cost -- the firm's actual cash payments for its imports
implicit cost -- the opportunity cost of nonpurchased inputs
marginal product of labor -- the change in input from one additional unit of labor
diminishing returns -- as one input increases while the other inputs are held fixed, output increases at a decreasing rate
total product curve -- a curve showing the relationship between the quantity of labor of the quantity of output produced
fixed cost (FC) -- costs that does not depend on the quantity produced
variable cost (VC) -- cost that varies as the firm changes its output
short run total cost (TC) -- the total cost of production in the short run, when one of more inputs (for example, the production facility) is fixed; equal to fixed cost plus variable cost
average fixed cost (AFC) -- fixed cost divided by the quantity produced
average variable cost (AVC) -- total variable cost divided by the quantity produced
short run average total cost (ATC) -- short run total cost divided by the quantity of output; equal to AFC plus AVC
short run marginal cost (MC) -- the change in short run total cost resulting from producing one or more unit of the good
long run total cost (LTC) -- the total cost of production in the long run when a firm is perfectly flexible in its choice of all inputs and can choose a production facility of any size
long-run average cost of production (LAC) -- long-run total cost divided by the quantity of output produced
long run marginal cost (LMC) -- the change in long-run cost from producing one or more unit of output
invisible input -- an input that cannot be scaled down to produce a smaller quantity of output
economies of scale -- a situation in which an increase in the quantity produced decreases the long-run average cost of production
minimum efficient scale -- the output at which the long-run average cost curve becomes horizontal
diseconomies of scale -- a situation in which an increase in the quantity produced increases the long-run average cost of production

Main points

The positively slow portion of the short run marginal cost curve (MC) results from diminishing returns.

The short run average total cost curve (ATC) is U-shaped because of the conflicting effects of:

• fixed costs being spread over a larger quantity of output
• diminishing returns.

The long-run average cost curve (LAC) is horizontal over some range of output because replication is an option, so doubling output will know more than double long run total cost.

The long-run average cost curve (LAC) is negatively slipped for small quantities of output because there are invisible input that cannot be scaled down and a smaller operation has limited opportunities for labor specialization.

Diseconomies of scale are rise if there are problems in coordinating a large operation or higher input costs in a larger organization.