Ch 7 - The Invisible Hand

The market equilibrium is only efficient if

+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.

Taylor used to work as a yoga instructor at the local gym earning $35,000 a year. Taylor quit that job and started working as a personal trainer. Taylor makes $50,000 in total annual revenue. Taylor's only out-of-pocket costs are $12,000 per year for rent and utilities, $1,000 per year for advertising and $3,000 per year for equipment. For Taylor to earn normal profit, Taylor's accounting profit would have to be ______.

35000 (Taylor's implicit cost is her former salary of $35,000)

The theory of the invisible hand

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 market outcome is fair and efficient in the long run

Central role of economic profit

When a firm's account profit is exactly equal to the opportunity cost of the inputs supplied by the firm's owners, the firm's economic profit is zero. For a firm to remain in business in the long run, it must earn an economic profit greater than or equal to zero.

efficient

a situation is efficient if no change is possible that will help some people without harming others

Economic rent is the part of the payment for a factor of production that is _____ the owner's reservation price.

above

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

accounting profit

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

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:

could make everyone better off

In general, price subsidies will _____ total economic surplus

decrease

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

differ from

The allocative function of price is to

direct resources away from overcrowded markets towards markets that are underserved.

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

If the owners of a business are receiving total revenues just sufficient to cover all of their explicit and implicit costs, then they are

earning a normal profit

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

economic profit

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

economic profit

The actual payments a firm makes to its factors of production and other suppliers are its (out-of-pocket payments)

explicit costs

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

fall

Suppose the figure below shows the cost curves for a representative firm in a perfectly competitive market, along with the equilibrium price.

is positive

If the price of a good or service lands above the equilibrium, we can conclude that ______.

it's always possible to design a transaction that will help both buyers or sellers

When a market is efficient and fair in the long run, it can be described as ______.

long-run competitive equilibrium

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 the firms in a perfectly competitive market are earning a positive economic profit, then in the long run we would expect

new firms entry into the market to drive economic profit to zero

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

the market equilibrium will not be socially optimal

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

If some supermarket checkout lines are significantly longer than others,

there will be a tendency for people to leave long lines for the shorter ones, making them grow longer

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.

Why do supermarket checkout lines all tend to be roughly the same length?

Because customers can save time by avoiding longer lines in favor of shorter ones.

Which of the following is an example of the rationing function of price?

Bill Gates purchasing the Mona Lisa for $5 billion (The rationing function of price is to distribute scarce goods and services among potential consumers, ensuring that those who get them are the ones who value them the most.)

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

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

True or false: Economists do not believe that it's important to address poverty and inequality because all that matters is whether the market is efficient.

False. Economists realize that there are important social goals besides economic efficiency, but they argue that it is easier to achieve those other goals if the market is efficient.

True or false: The market equilibrium is always efficient.

False. The market equilibrium may not be efficient if the market is not perfectly competitive or if the market supply curve and the market demand curve do not capture all of the relevant costs and benefits of a good.

Pareto Efficiency

If price and quantity take anything other than their equilibrium values, a transaction that will make at least some people better off without harming others can always be found.

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.

Which of the following best describes how a perfectly competitive industry would respond to a sudden increase in popularity of the product? The market demand curve would shift to the right, leading to

a higher equilibrium price in the short run and entry into the market in the long run. (The demand shift increases price and leading to positive economic profit. In the long run, this economic profit will prompt new firms to enter the market.)

barrier to entry

any force that prevents firms from entering a new market

If the market equilibrium is efficient, then:

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

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

efficient

It's always possible to design a transaction that will help both buyers or 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 the market for ice cream is in a long-run equilibrium, and the demand for ice cream falls, then the price of ice cream will:

fall in the short run, resulting in economic losses and exit from the market

The opportunity costs of all the resources supplied by a firm's owners are the firm's

implicit costs

Adam Smith's theory of the invisible hand states that the actions of independent self-interested buyers and sellers will ______ result in the most efficient allocation of resources

often

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

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

If there are barriers to entry and exit, then

the allocative function of price cannot operate.

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.

Economic efficiency is important because when markets are efficient

there are no more resources available to achieve all our other goals

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

in equilibrium

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

no further

The difference between a business's accounting profit and its economic profit

normal profit

The producer surplus is represented by the

area below the price. (consumer surplus is above)

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

not always