Ch. 7- Efficiency, Exchange, and the Invisible Hand in Action

Profit

A copyright provides no guarantee of a...

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.

Allocative Function of Price.

Changes in prices direct resources away from *overcrowded* markets and towards markets that are underserved.

Possible

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.

Economic Loss

An economic profit is less than zero.

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

The Equilibrium Principle states that...

No further

When the market is in equilibrium there are _________ opportunities for gain available to individuals.

Barrier to Entry

Any force that prevents firms from entering a new market. May results from practical as well as legal constraints.

Rationing Function of Price

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

there are important social goals besides economic efficiency.

Economists believe that...

*Opportunity Cost* of the resources owners supply their firms.

Normal profit is...

in the short run.

One reason that firms have a strong incentive to develop cost-saving innovations is that these innovations enable the firm to earn an economic profit...

Economic Rent

The 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.

Market Efficiency

There must be a better alternative policy. Price controls on a goods that prevent the market from reaching equilibrium, means forgoing transactions that would benefit some people without harming others.

In equilibrium

When the market is _____________, there are no further opportunities for gain available to individuals.

Efficient (Pareto Efficient)

A situation is efficient if *no change is possible* that will help some people without harming others. Economic surplus is maximized, enabling society easily achieve its goals.

Negative

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

fall as new firms enter the market.

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

Neither entry into nor exit from the market.

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

Efficient

If it's not possible to find a transaction that will make some people better off without harming others, then the market equilibrium is...

Fall

If the government were to subsidize the price of cars, it's likely that total economic surplus would...

Does not always coincide

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

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

The market equilibrium is only efficient if:

Differ from

The market equilibrium will NOT be socially optimal when the costs and benefits to individual participants in the market _________those experienced by society as whole.

Normal Profit

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

- Economic surplus is maximized, enabling society easily its goals - It's not possible to find a transaction that will make some people better off without harming others.

If the market equilibrium is efficient, then:

Reduce the size of the pie.

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

The allocative function of price cannot operate.

If there are barriers to entry and exit, then...

Decrease

In general, price subsidies will ____________ total economic surplus.

Economic profit is negative.

In the *long run* a firm should exit the market

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

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

Existing firms to exit the market.

In the *long run*, economic loss creates an incentive for...

Zero economic profit

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

either above or below the equilibrium price.

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

Could make everyone better off

Price controls are often designed to help the poor, but the fact that they reduce total economic surplus means that alternative policies such as direct income transfers to the poor:

Yes

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?

Explicit Costs

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

Not always

The broader interests of society are ________ promoted by the individual pursuit of self-interest.

Accounting Profit

The difference between a firm's total revenue and its explicit costs.

Economic Profit (Excess Profit)

The difference between a firm's total revenue and the sum of its explicit and and implicit costs.

Implicit Costs

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