Practice Chapter 7 - Efficiency, Exchange, and the Invisible Hand in Action

Suppose James is willing to work as a chef as long as he is paid at least $2,700 per month. If he currently earns $3,000 per month then his economic rent is

$300 per month

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

allocative function of price.

Economic Profit

the difference between a firm's total revenue and the sum of its explicit and implicit costs Economic profit = Total revenue - Explicit Costs - 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 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 more resources available to achieve all our other goals.

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 ear

zero economic profit

In the long run, in a market in which firms are earning an economic loss, exit will occur until all firms earn

zero economic profit

Suppose Mrs. Meadows is willing to sell her famous homemade chocolate chip cookies as long as she is paid at least $1.25 for each. If Mr.s Meadows currently sells her cookies for $3.25 each, then her economic rent is:

$2.00 per cookie

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 economic profit?

$50,000 per year

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 without harming others.

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

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

Economic Profit

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

Exit the market

True of False: The market equilibrium is always efficient.

False

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

a barrier to entry

Efficient (Pareto Efficient)

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

Allocative Function of Price

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

The rational functioning of price is to

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

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

If the firms in a market are earning a positive economic profit, then in the long run, _______ the market will lead economic profit to __________.

entry into ; fall

Rationing function of price

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

If the market for soccer balls is in a long run equilibrium, and the demand for soccer balls falls, then we would expect: (select all that apply)

- firms to exit the market in the long run - the price of soccer balls to fall in the short run

The figure on the right shows the daily market for wheat. If the government imposes a price ceiling of $5 per bushel, the loss in total economic surplus (relative to when the market is unregulated) is _______ dollars per day.

30,000 $3 x 20000 / 2 = 30,000

Smart for One, Dumb for All

Adam Smith;s profound insight was that all individual pursuit of self-interest often promotes the broader interests of society. But unlike some of his modern principles, Smith was under no illusion that this was always the case.

Suppose Min-Jun owns a small convenience store. Each year, his total revenue is $550,000, his explicit costs are $480,000, and his implicit costs are $90,000. Should Min-Jun continue to operate his store in the long run?

No

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.

The market equilibrium is efficient if

it's not possible to find a transaction that will help some people without harming others.

Accounting Profit

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

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 costs of all the resources she puts into her business is $100,000 per year. What is Valerie's accounting profit?

$50,000 per year

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

positive economic profit

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

Explicit Costs

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

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

If there are barriers to entry and exit, then

the allocative function of price cannot operate.

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.

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 $3 x 10,000 / 2 = 15,000

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

20,000

Normal Profit

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

Economic Loss

and economic profit that is less than zero

Barrier to Entry

any force that prevents firms from entering a new market

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

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

fall

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

in equilibrium

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 an input that is above the owner's reservation price is economic _____.

rent

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

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

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 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 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

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

neither entry into nor exit from the market.

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

not always