Econ test 2
invisible hand theory
actions of independent, self-interested buyers and sellers will often (not always) result in the most efficient allocation of resources
explicit costs
actual payments a firm makes to its factors of production
a defining characteristic of all perfectly competitive markets is:
all firms sell the same standardized product
A market equilibrium is only efficient if:
all relevant costs and benefits are reflected in the market supply and demand curves.
The role that prices play in directing resources away from overcrowded markets and towards markets that are underserved is known as the ______ function of price.
allocative
economic loss
an economic profit that is less than zero
Barriers to entry
any force that prevents firms from entering a new market
total cost
the sum of all payments made to the firm's fixed and variable factors of production o Total cost = fixed cost + variable cost
fixed cost
the sum of all payments made to the firm's fixed factors of production o The fixed cost is always the same, EVEN if the firm produces no output
Adam Smith's theory of the invisible hand posits that the most efficient allocation of resources is often achieved by:
the actions of independent, self-interested buyers and sellers.
Economic rent is:
the difference between the payment made to the owner of a factor of production and the owner's reservation price.
Efficiency is an important goal because when markets are efficient:
there are more resources available to achieve other goals.
If there is excess demand in a market, then this suggests that:
there is an opportunity for mutually beneficial trades.
law of diminishing returns
when some factors of production are fixed, increased production of the good eventually requires ever larger increases in the variable factor
If the market supply curve does not capture all of the costs to society of producing an additional unit of good, then:
the market equilibrium will not be efficient.
implicit costs
the opportunity costs of the resources supplied by the firm's owners
when the price of a variable factor of production increases:
the profit maximizing level of output falls
Price taker
• : a firm that has no influence over the price at which it sells its product
Profit maximizing firms
• Profit= Total revenue- total cost o Total cost includes EXPLICIT and IMPLICIT COSTS • Profit maximizing firms aim to make profit as large as possible
Production
• a firm produces a good by converting factors of productions into that good
imperfectly competitive market
• a firm that has at least some control of the market price of its product
Perfectly competitive market
• a market in which no individual supplier (or buyer) has significant influence on the market price of the product o Since individual sellers (and buyers) cannot affect the market price they are price takers
fixed factor of production
• an input whose quantity cannot be altered in the short run
marginal cost
• the cost of producing one additional unit of output o In the short run, to increase production, the firm can only do so by increasing variable factors of production
PRICE < MARGINAL COST the firm makes a
LOSS out of that unit. It does not want to produce that unit of output
efficient
a situation is efficient if no change is possible that will help some people without harming others
normal profit
accounting profit - economic profit
economic profit
(aka excess profit) economic profit = total revenue - explicit costs - implicit costs
variable cost
-the sum of all payments made to the firm's variable factors of production o The variable cost increase as the firm uses more variable factors of production o In the short run, to increase production, the firm can only do so by increasing variable factors of production
Characteristics of perfectly competitive markets
1. ALL FIRMS SELL THE SAME STANDARDIZED PRODUCT 2. THE MARKET HAS MANY BUYERS AND SELLERS EACH OF WHICH BUYS AND SELLS ONLY A SMALL FRACTION OF THE QUANTITY EXCHANGED 3. PRODUCTIVE RESOURCES ARE MOBILE 4. buyers and sellers are well informed
long run
: a period of time of sufficiently length that all the firms
Short run
A period of time sufficiently short that at least some of the firm's factors of production are FIXED
accounting profit
Accounting profit = total revenue - explicit costs
Which of the following is NOT necessarily true in a market equilibrium? -Price represents the value of an extra unit of consumption. -Both rich and poor have adequate access to the good. -Price represents the cost of an extra unit of production. -All mutually beneficial trades have been made.
Both rich and poor have adequate access to the good.
To choose the output that maximizes profit, a perfectly competitive firm wants to produce every unit of output for which:
ITS PRICE IS GREATER OR EQUAL TO ITS MARGINAL COST OF PRODUCTION
When will entry and exit from a market stop?
Entry and exit stop when there is no economic profit and no economic loss
PRICE > MARGINAL COST the firm makes a
PROFIT out of that unit. It wants to produce that unit of output
Which of the following statements about implicit costs is true?
They measure the forgone opportunities of the firm's owners.
The short run is best defined as:
a period of time sufficiently short that at least one factor of production is fixed
The allocative function of price cannot operate unless there is:
both free entry and free exit.
allocative function
changes in prices direct resources away from overcrowded markets and toward markets that are underserved
rationing function
changes in prices distribute scarce goods to those consumers who value them most highly
In perfectly competitive markets, an implication of entry and exit in response to economic profit and loss is that:
firms will earn zero economic profit in the long run.
A price-taker faces a demand curve that is:
horizontal at the market price
The most important challenge facing a firm in a perfectly competitive market is deciding:
how much to produce
If it is possible to make a change that will help some people without harming others, then the situation is:
inefficient
According to the law of diminishing returns, when some factors of production are fixed, in order to increase production by a given amount, a firm will eventually need to add successively:
larger and larger quantities of the variable factors of production.
The primary objective of most private firms is to:
maximize profit
Unlike economic profit, economic rent:
may not be driven to zero by competition.
A situation is efficient if it is:
not possible to find a transaction that will make at least one person better off without harming others.
the rule for a firm to maximize profit
o Cant choose price o Choose how many units of output to produce o Hire inputs to produce the output at the lowest cost possible (ignore)
Profit maximization
o Goods and services are produced by different organizations with different motives: ♣ Profit maximizing firms ♣ Nonprofit organizations ♣ Governments
Factor of production
o an input used in the production of a good or a service Example: land, labor, capital, and entrepreneurship Input: factors of production Output: describe the product
Market supply curve
o sum at each price of all individual seller's supply
economic rent
portion of a payment to a factor of production that exceeds the owner's reservation price
The percentage change in quantity supplied that results from a 1 percent change in price is known as the:
price elasticity of supply
The Cost-Benefit Principle tells us that a firm should continue to expand production as long as:
price of the good is greater than its marginal cost
Total revenue minus both explicit and implicit costs defines a firm's:
profit
price elasticity of supply equation
quantity/ price
