(Complete) Ch.7: Efficiency, Exchange, and the Invisible Hand in Action

In the long run, new firms will enter a market if existing firms are earning a

positive economic profit

If the price of a product is below the equilibrium price, then it's ______ to design a transaction that will help both buyers and sellers.

possible

barrier to entry may result from

practical and legal constraints.

If the total economic surplus from a market is thought of as a pie to be divided among the participants in the market, then imposing price controls will:

reduce the size of the pie

The part of the payment for a factor of production that is greater than the owner's reservation price is called economic __________.

rent

Total Surplus Formula

total surplus = consumer surplus + producer surplus

The figure on the right shows the market for shampoo. At the equilibrium price of $4 per bottle, total consumer surplus is _______ dollars per month.

$40,000 Consumer surplus is the area below the demand curve above price. In this case, ($4x20,000)/2= 40,000.

John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense: Amount: Labor $2,000 Food and drink 500 Electricity 100 Vehicle lease 150 Rent 500 Interest on loan 1,000 for equipment d. Suppose John had not had to get a $10,000 loan at an annual interest rate of 10 percent to buy equipment, but instead had invested $10,000 of his own money in equipment. Calculate John's annual accounting profit

$3,250 John's accounting profit equals his revenue minus his explicit costs. If he doesn't need a loan, then his explicit costs equal $3,250. So, his accounting profit equals $1,750 (= $5,000 − $3,250).

Suppose Valerie owns a hardware store. Each year, her revenue is $600,000 and her explicit costs are $550,000. In addition, Valerie estimates that the opportunity cost of all the resources she puts into her business is $100,000 per year. What is Valerie's normal profit?

$100,000 per year Normal profit is equal to the opportunity costs of the resources supplied by the firm's owners, which in this case is $100,000 per year.

The figure on the right shows the market for shampoo. If the government imposes a price ceiling of $3 per bottle, the loss in economic surplus (relative to when the market is unregulated) is _____ dollars per month

$15,000 Lost surplus is $3 x 10,000 / 2 = $15,000

The figure on the right shows the daily market for wheat. At the equilibrium price of $7 per bushel, total producer surplus is ______ dollars per day.

$180,000 Producer surplus is the area below price above the supply curve. In this case, ($6X60,000)/2 =$180,000

The figure on the right shows the market for shampoo. At the equilibrium price of $4 per bottle, the producer surplus is 20,000 dollars per month.

$20,000 Producer surplus is the area below the demand curve above price. In this case, ($2x20,000)/2= $20,000.

John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense: Amount: Labor $2,000 Food and drink 500 Electricity 100 Vehicle lease 150 Rent 500 Interest on loan 1,000 for equipment e. As in part b, suppose John could earn $1,000 per year as a recycler and he has to pay $1,000 per year in interest on his loan, but, unlike part b, suppose John likes recycling just as well as running the café. How much additional revenue would the café have to collect each year to earn a normal profit?

$250 To earn a normal profit, the café would have to cover all its implicit and explicit costs. The opportunity cost of John's time is $1,000 per year while the café's accounting profit is only $750 per year. Thus, the café would have to earn additional revenues of $250 per year in order for John to make a normal profit.

The figure on the right shows the daily market for wheat. At the equilibrium price of $7 per bushel, total surplus is _______ dollars per day.

$270,000 Total surplus is the sum of consumer and producer surplus. In this case, $90,000+$180,000= $270,000.

Suppose Valerie owns a hardware store. Each year, her revenue is $600,000 and her explicit costs are $550,000. In addition, Valerie estimates that the opportunity cost of all the resources she puts into her business is $100,000 per year. What is Valerie's accounting profit?

$50,000 per year Accounting profit is the difference between a firm's total revenue and its explicit costs. In this case, $600,000-$550,000-$50,000.

Suppose Michelle owns a women's clothing boutique. Each year, her total revenue is $300,000 and her explicit costs are $160,000. In addition, Michelle estimates that the opportunity cost of the resources she puts into her business is $90,000 per year. What is Michelle's economic profit?

$50,000 per year Economic profit is the difference between a firm's total revenue and the sum of its explicit and implicit costs. In this case, $300,000-$160,000-$90,000 $50,000.

Suppose Valerie owns a hardware store. Each year, her revenue is $600,000 and her explicit costs are $550,000. In addition, Valerie estimates that the opportunity cost of all the resources she puts into her business is $100,000 per year. What is Valerie's economic profit?

$50,000 per year Economic profit is the difference between a firm's total revenue and the sum of its explicit and implicit costs. In this case, $600,000-($550,000 $100,000)--$50,000.

The figure on the right shows the market for shampoo. At the equilibrium price of $4 per bottle, total surplus is _______ dollars per month.

$60,000 Total surplus is ($6X20,000)/2 =$60,000

John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense: Amount: Labor $2,000 Food and drink 500 Electricity 100 Vehicle lease 150 Rent 500 Interest on loan 1,000 for equipment a. Calculate John's annual accounting profit.

$750 John's accounting profit is his revenue minus his explicit costs:$5,000 - $4,250 = $750

The figure on the right shows the daily market for wheat. At the equilibrium price of $7 per bushel, the consumer surplus is _______ dollars per day.

$90,000 Consumer surplus is the area below the demand curve above price. In this case, ($3x60,000)/2= $90,000

Suppose Michelle owns a women's clothing boutique. Each year, her total revenue is $300,000 and her explicit costs of $160,000. In addition, Michelle estimates that the opportunity costs of the resources she puts into her business is $90,000 per year. What is Michelle's normal profit?

$90,000 per year

Suppose Emily is an exceptionally talented architect. Her opportunity cost of working as an architect is $60,000 per year, and her salary at the architectural firm where she works is $150,000 per year. Thus, Emily's economic rent from being an architect is:

$90,000 per year Economic rent is the part of the payment for a factor of production that is above the owner's reservation price: $150,000-$60,000=$90,000

If the market for calculators is in a long run equilibrium, and the demand for calculators increases, then we would expect:

-The price of calculators to rise in the short run -firms to earn an economic profit in the short run.

If the market equilibrium is efficient, then:

-it's not possible to find a transaction that will help some people without harming others. - economic surplus is maximized, enabling society easily achieve its goals.

The Market equilibrium is only efficient if

-the market supply curve captures all of the relevant costs of producing another unit of the good. - the market demand curve captures all of the relevant benefits of buying another unit of the good. - the market is perfectly competitive.

Accounting Profit Formula

Accounting Profit= total revenue - explicit costs

Invisible Hand Theory

Adam Smith's theory that the actions of independent, self-interested buyers and sellers will often result in the most efficient allocation of resources

The role that prices play in directing resources away from overcrowded markets towards markets that are underserved is known as the

Allocative function of price.

Any force that prevents firms from entering a new market is called

Barrier to Entry

The figure on the right shows the daily market for wheat. With a government imposed a price ceiling of $5 per bushel, the blue shaded region represents:

Consumer surplus

Economic Profit formula

Economic Profit= accounting profit - Explicit costs- implicit costs

True/False The economic maxim "There's no cash on the table" means that there are never any unexploited economic opportunities.

False. The maxim tells us that there are no unexploited economic opportunities when the market is in long-run equilibrium. In fact, there often are unexploited economic opportunities in the short run when markets are not in equilibrium.

The figure on the right shows the daily market for wheat. With a government imposed a price ceiling of $5 per bushel, the red shaded region represents:

Lost economic surplus

Suppose Woo-Jin owns a shoe repair business. His accounting profit is $48,000 per year and his implicit costs are $60,000 per year. Should Woo-Jin continue to operate his shoe repair business in the long run?

No Since Woo-Jin's accounting profit is less than his implicit costs, his economic profit is negative, implying that he should not continue to operate his shoe repair business.

John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense: Amount: Labor $2,000 Food and drink 500 Electricity 100 Vehicle lease 150 Rent 500 Interest on loan 1,000 for equipment c. Suppose the café's revenues and expenses remain the same, but recyclers' earnings rise to $1,100 per year. Is the café making an economic profit? Should John stay in the café business?

No, the café is making an economic loss of $75 per year No, he should not stay in the café business. In this case, John's opportunity cost of running the café is $825 per year ($1,100 − $275 = $825). Thus, the café is earning an economic loss of $75 per year ($5,000 − $4,250 − $825 = −$75). Since the café is earning an economic loss, John should not stay in the café business.

The opportunity cost of the resources supplied by a firm's owners is the firm's

Normal profit

Normal profit Formula

Normal profit= Accounting profit- Economic profit

The figure on the right shows the daily market for wheat. With a government imposed a price ceiling of $5 per bushel, the Green shaded region represents:

Producer surplus

Explicit costs

The actual payments a firm makes to its factors of production and other suppliers

Normal profit

The opportunity cost of the resources supplied by the firm's owners, equal to accounting profit minus economic profit.

Adam Smith's theory that the actions of independent self-interested buyers and sellers will often result in the most efficient allocation of resources is

The theory of the invisible hand

Accounting profit is the difference between -a firm's total revenue and its implicit costs. -a firm's total revenue and the sum of its explicit and implicit costs. -a firm's total revenue and its explicit costs.

a firm's total revenue and its explicit costs.

Suppose Ji-woo owns a self-serve frozen yogurt store. Each year, her total revenue is $220,000, her explicit costs are $110,000, and her implicit costs are $80,000. Should Ji-woo continue to operate her store in the long run?

Yes Ji-Woo's economic profit is $220,000-$110,000-$80,000= $30,000. Since her economic profit is positive, she should continue to operate her store.

John Jones owns and manages a café in Collegetown whose annual revenue is $5,000. Annual expenses are as follows: Expense: Amount: Labor $2,000 Food and drink 500 Electricity 100 Vehicle lease 150 Rent 500 Interest on loan 1,000 for equipment b. Suppose John could earn $1,000 per year as a recycler of aluminum cans, but he prefers to run the café. In fact, he would be willing to pay up to $275 per year to run the café rather than to recycle. Is the café making an economic profit? Should John stay in the cafe business?

Yes, the café is making an economic profit of $25 per year. Yes, he should stay in the café business. In this case, John's opportunity cost of running the café is $725 per year ($1,000 − $275 = $725). Thus, the café is making an economic profit of $25 per year ($5,000 − $4,250 − $725 = $25). Since the café is earning an economic profit, John should stay in the café business.

Economic profit is the difference between

a firm's total Revenue and the sum of its explicit and implicit costs

Suppose the weekly demand and supply curves for used DVDs in Lincoln, Nebraska, are as shown in the Use the following values for the graph above: A 10.00 B 9.60 C 9.00 D 6.60 E 5.00 F 2 G 5 H 17 I 50 Calculate the following at the equilibrium price of $9.00. a. The weekly consumer surplus at the market equilibrium price. Instruction: Enter your response rounded to two decimal places. $ _____ per week. b. The weekly producer surplus at the market equilibrium price. Instruction: Enter your response rounded to two decimal places. $ _____ per week. c. The maximum weekly amount that producers and consumers in Lincoln would be willing to pay to be able to buy and sell used DVDs in any given week (total economic surplus). Instruction: Enter your response rounded to two decimal places. $ _____ per week.

a. $2.50 b. $10.00 c. $12.50 Explanation: a. Consumer surplus is the triangular area between the demand curve and the equilibrium price. Its area is equal to (1/2)(base)(height). The base is 5 units and the height is 1 units, measured in dollars. Therefore, consumer surplus is (1/2)($5/unit)(1 units/week) = $2.50 per week. b. Producer surplus is the triangular area between the equilibrium price and the supply curve. Using the base-height formula, it is (1/2)($5/unit)(4 units/week) = $10.00 per week. c. The maximum weekly amount that consumers and producers together would be willing to pay to trade in used DVDs is the sum of the gains from trading in used DVDs — namely, the total economic surplus generated per week, which is $12.50 per week.

The fact that firms enter industries in response to positive economic profit and leave industries in response to economic loss illustrates the

allocative function of price.

Economic loss

an economic profit that is less than zero

barrier to entry

any force that prevents firms from entering a new market

True/False Firms in competitive environments make no accounting profit when the market is in long-run equilibrium.

b. False. Firms in long-run equilibrium make zero economic profits. They make a positive accounting profit since, in order to stay in business, the firm must earn enough revenue to cover both explicit costs and implicit costs. Thus, accounting profit, which is equal to total revenue minus explicit costs, must equal the opportunity cost of the owner's resources that have been invested in the firm.

True/False Firms that can introduce cost-saving innovations can make an economic profit in the short run.

c. True. Firms that introduce cost-saving innovations can earn economic profits until other firms adopt their innovations. As the innovations spread, the industry supply curve will shift to the right, causing the market price of the good to fall and short-term economic profits to fall.

allocative function of price

changes in prices direct resources away from overcrowded markets and toward markets that are underserved

rationing function of price

changes in prices distribute scarce goods to those consumers who value them most highly

accounting profit

difference between a firms total revenue and its explicit costs

The rationing function of price is to

distribute scarce goods to those consumers who value them the most highly

The individual pursuit of self-interest ________ with the broader interests of society.

does not always coincide

If a firm's economic loss is $10,000, then its is________$10,000.

economic profit

It's always possible to design a transaction that will help both buyers and sellers whenever the price of a product is

either above or below the equilibrium price

In the long run, economic loss creates an incentive for

existing firms to exit the market. If firm's are earning an economic loss, then this implies that they are earning less than their opportunity cost of being in the market, so they will exit.

If the firms in a market are earning an economic loss, then in the long run there will be _____ the market, leading the equilibrium price to _____.

exit from ; rise An economic loss implies that producers are earning less than their opportunity cost, so some firms will exit, leading to a decrease in market supply and an increase in equilibrium price.

If a firm is earning a negative economic profit, then in the long run the firm should

exit the market. In the long run firms should exit a market whenever economic profit is negative.

The actual payments a firm makes to its factors of production and other suppliers are its

explicit costs.

If a firm is earning a positive economic profit, then over time we would expect that firm's profit to

fall as new firms enter the market. Positive economic profit creates an incentive for new firms to enter the market, leading supply to increase and equilibrium price to decrease, which in turn will lower the profit of firms in the market.

When the market is ___________, there are no further opportunities for gain available to Individuals.

in equilibrium

Suppose it's possible to find a transaction that will make some people better off without hurting others. In this case, we know the market equilibrium

is not socially optimal

In general price subsidies will___ total economic surplus

lower/decrease

If a firm earns an economic loss, then its economic profit is

negative

If all of the firms in a market are identical and the equilibrium price in the market equals the minimum of each firm's average total cost curve, then we would expect

neither entry into nor exit from the market

If all the firms in a market earn zero economic profit, then we would expect

neither entry into nor exit from the market.

Economic rent

that part of the payment for a factor of production that exceeds the owner's reservation price, the price below which the owner would not supply the factor

The Equilibrium, or No Cash on-the-Table. Principle tells us

that when a market reaches equilibrium no further opportunities for gain are available to individuals.

economic profit (or excess profit)

the difference between a firm's total Revenue and the sum of its explicit and implicit costs

When the costs and benefits to individual participants in the market differ from those experienced by society as a whole,

the market equilibrium will not be socially optimal.

Implicit costs

the opportunity costs of the resources supplied by the FIRM's owners.

A firm's implicit costs are

the opportunity costs of the resources supplied by the firm's owners.

A firm that adopts a new cost-saving innovation will earn an economic profit in

the short run

Economists believe that

there are important social goals besides economic efficiency

The equilibrium principle states that:

when the market is in equilibrium, there are no further opportunities for gain available to individuals

In the long run, all firms in an industry will tend to earn

zero economic profit

In the long run, in a market in which firms are earning a positive economic profit, entry will occur until all firms earn:

zero economic profit Once economic profit has been driven to zero, there is no incentive for firms to enter the market.