01:220:102 Study Guide - Durable Good, The Variable, Variable Cost
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Section I: Introduction to Microeconomics
I. Mathematical Fundamentals: Variables
a. Variable = abstract representation a real number
b. Variables represent the key economic magnitudes of interest:
p = price of consumable good ($/unit), x = quantity (units), q = quality
s = price of durable good, z = quantity of durable good
r = interest rate (fraction: 10% implies 0.10), t = time (years)
u = utility (utils), v = value ($), w = wage rate ($/hour), y = expenditures ($)
C = cost
D = demand
II. Stocks versus Flows
a. Stock is an amount of units of a good or an amount of dollars held by a firm or consumer at a
given point in time
b. Flow is an annual amount of units of a good or service produced by a firm or consumed by a
c. FV(dollar amount NOW , interest rate ; future year) is a function that converts the dollar
amount NOW into the Future Value of that dollar amount in the specified future year.
FV($1000,r; n) = (1+r)n · ($1000)
d. PV(dollar amount then , interest rate , future year) is a function that converts the dollar amount
receive in the specific future year into the Present Value of that dollar amount NOW.
PV($1000, r ; n) = ($1000) / (1+r)n
III. What is a Bond?
a. Bonds are promises to pay (IOUs) issued by governments and corporations in order to borrow
Standardized contract to pay money in the future.
Issued and sold to individuals, banks, and investment funds.
Price of the bond is the loan and the contract is the repayment.
b. Each Bond Issue has a standardized obligation of repayments
Coupon Payment each year (often set as % of the Face Value)
Term of years over which the payments are made.
Face Value payment at the end of the Term (at Maturity).
Coupon Rate (CR) = Annual Coupon Payments / Face Value
c. Bond has both flow and stock payments over time.
Bond has a FLOW of Coupon Payments over the Term of years.
Bond has a STOCK of the Face Value payment at Maturity.
The Present Value is the willingness to pay (or sell) a Bond.
d. Types of Bonds
Zero-Coupon Bond, also called Discount Bonds
Face Value paid at maturity (end of the Term)
But NO coupon Payments paid during the Term
No Term and thus NO Face Value
Coupon Payments paid every year FOREVER
Face Value paid at maturity
Coupon Payments paid every year, starting in next year, until maturity
Any Bond with a low “Bond Rating” because the corporation who issued the
Bond may stop making the payments (default) and declare bankruptcy.
Higher coupon payments
Junk Bond is a bond with a high probability of default
The Probability of Default reduces the Present Value of the Bond
Lets calculate the “Expected” Present Value of a Junk Bond
A Bond which specifies “Collateral” in the contract.
Collateral is assets of the corporation that can be taken by the Bond Holders if
the corporation stops making the payments (default).
e. What is a Share of Common Stock?
Common Stock is issued by corporations to borrow money.
Each Share of Common Stock is paid dividends and can be resold
The “Expected” Present Value of a Common Stock can be calculated from the expected
dividends and the expected future market price.
Section 2: Costs and Supply of Competitive Firms
I. Why Study the Cost Function?
a. Supply: The Cost Function will determine how much firms are willing to produce and sell to
consumers at different prices.
b. Investment: The Cost Function and the price will determine the profitability of the firm and the
incentive to invest and expand.
c. Competition: The Cost Function is an important factor for understanding competition among
firms producing similar goods.
d. Entry and Exit: The Cost Function is an important factor in determining the ease or difficulty of
entry into an industry.
II. Non-Recurring or One-Time Costs
a. Some costs are incurred only once and NOT incurred every year
b. SUNK COSTS are one-time costs (stock) which cannot be recovered if the firm shuts down
c. RECOVERABLE COSTS are one-time costs which can be recovered if the firm shuts down.
d. One-time costs are often partially sunk and partially recoverable.
e. One-time costs are important for making the one-time decisions whether to enter or exit the
III. Recurring or Annual Costs: Variable Costs
a. Some costs which are incurred every year depend on the output produced by the firm.
Section i: introduction to microeconomics: mathematical fundamentals: variables, variable = abstract representation a real number, variables represent the key economic magnitudes of interest: P = price of consumable good ($/unit), x = quantity (units), q = quality. S = price of durable good, z = quantity of durable good. R = interest rate (fraction: 10% implies 0. 10), t = time (years) U = utility (utils), v = value ($), w = wage rate ($/hour), y = expenditures ($) Pv(, r ; n) = () / (1+r)n. What is a bond: bonds are promises to pay (ious) issued by governments and corporations in order to borrow money. Standardized contract to pay money in the future. Issued and sold to individuals, banks, and investment funds. Price of the bond is the loan and the contract is the repayment: each bond issue has a standardized obligation of repayments. Coupon payment each year (often set as % of the face value)