Ch. 9 Flashcards
long run
period of time in which all factors of production and costs are variable.
firms are able to adjust all costs
short run
firms are only able to influence prices through adjustments made to production levels. Additionally, while a firm may be a monopoly in the short term, they may expect competition in the long run.
In macroeconomics, the long run is the period when the
general price level, contractual wage rates, and expectations adjust fully to the state of the economy, in contrast to the short run, when these variables may not fully adjust.
problems with Good to Great book
confuse correlation with causation and to ignore the long run forces that tend to erode profit
high profit brings attention to the value a firm creates and customers, suppliers, competitors, substitutes, and new entrants will try to capture some of the values.
perfectly competitive industry
firms produce a product or service with very close substitutes, meaning demand is very elastic;
firms have many rivals and no cost advantages;
the industry has no entry or exit barriers.
the demand curve for the output of a perfectly competitive firm is
flat (perfectly elastic)
in competitive firms if price is above marginal cost
it sells more
in competitive firms if price is below marginal cost
it sells less
industries that come close to a perfectly competitive are
formal stock exchange and agricultural commodities
benchmark of perfectly competitive firms helps
see the long-run forces that determine long-run industry performance.
demand increases and price increase for a while because
This “for a while” is the period that economists call the “short run.” Above-average profit lasts only for a while because profit attracts capital to the industry; existing firms expand capacity, or new entrants come into the industry. This increases industry supply, which leads to a decrease in price. Entry and capacity expansion continue, and price keeps falling until firms in the industry are no longer earning above-average profit. At this point, capital stops flowing into the industry, and we say that the industry has reached long-run equilibrium.
long-run equilibrium
when firms are in long-run equilibrium, economic profit is zero (including the opportunity cost of capital), firms break even, and price equals average cost (i.e., no one wants to enter or leave the industry).
In the long run, no competitive industry earns more than an average rate of return. If it does…
firms will enter the industry or expand, increasing supply until the profit rate returns to average.
In the long run, no competitive industry can earn
less than an average rate of return.
if firms earn less than an average return….
firms will exit the industry or reduce capacity, decreasing supply until the profit rate returns to average.
A competitive firm can earn positive or negative economic profit in the…
short run but only until entry or exit occurs. In the long run, competitive firms earn only an average rate of return.
When firms are in long-run equilibrium, economic profit is
zero (including the opportunity cost of capital), firms break even, and price equals average cost.
mean reversion
suggests that performance eventually moves back toward the mean or average.
where the mean is zero economic profit
in the short run,
price and quantity will increase and firms will earn above-average profit.
in the long run,
above-average profits will attract new assets into the industry, which will increase supply until profits fall back to the average
asset mobility
the major competitive force driving profits to zero
positive profit attracts
entry
negative profit attracts
exit
moving assets from lower valued areas to higher valued areas is the force that attracts
equilibrium
indifference principle
developed by Steven Landsburg for asset mobility.
If an asset is mobile, then in long-run equilibrium, the asset will be indifferent about where it is used; that is, it will make the same profit no matter where it goes.
when long-run equilibrium is reached, capital is indifferent about where it goes because
it earns the same return (its opportunity cost) regardless of the industry.
wage also adjusts equilibrium
take a long time for entry to move wages to an equilibrium level, especially in professions that require a long period of training.
compensating wage differentials
differences in wages that reflect differences in the inherent attractiveness of various professions or jobs (once equilibrium has been reached).
Once equilibrium is reached, differences in wages, called compensating wage differentials, reflect
differences in the inherent attractiveness of various professions.
the forces of competition allocate resources to
where they are most highly valued and allow our economy to adapt rapidly to shocks.
the higher return on a risky stock is called
risk premium
analogous to a compensating wage differential
risk premium is
higher expected rates of return that compensate investors in risky assets. In equilibrium, differences in the rate of return reflect differences in the riskiness of an investment.
In equilibrium, differences in the rate of return reflect
differences in the riskiness of an investment.
monopoly
a firm that is the single seller in its market. Monopolies have market power because they produce a product or service without close substitutes, they have no rivals, and barriers to entry prevent other firms from entering the industry.
monopolies are characterized by
producing a product or service with no close substitutes.
Monopolies have no rivals.
Barriers to entry prevent other firms from entering the industry.
Unlike a competitive firm, a monopoly firm can earn
positive profit—an above-average rate of return—for a relatively long time.
monopolies are not permanent as barriers to entry…
do not last forever
other firms can compete with monopolies by
developing substitutes or inventing new products that compete with the monopoly’s products and erode monopoly profits
The main difference between a competitive firm and a monopoly
is the length of time that a firm can earn above-average profit.
when are you indifferent between two assets?
when the attributes are different.
Pat is the owner of United Local Supply, which makes zero economic profit. Pat is
a. on the brink of going out of business. b. incurring short-run losses. c. making a return equal to his or her opportunity cost. d. trading off the short-run for the long-run.
c. making a return equal to his or her opportunity cost.
Which of the following characteristics is most consistent with a perfectly competitive market?
a. Firms earn positive economic profit. b. There are just a few sellers in the market. c. Firms are able to enter and exit the market freely. d. All of the above
c. Firms are able to enter and exit the market freely.
If firms in a competitive industry begin to earn profit in the short run, new firms will enter. This will shift the industry
a. demand curve to the right, meaning market price will rise. b. demand curve to the left, meaning market price will fall. c. supply curve to the right, meaning market price will fall. d. supply curve to the left, meaning market price will rise.
c. supply curve to the right, meaning market price will fall.
You have recently been hired to advise the owners of Kenfield Insect Ltd. (KIL), which operates in a perfectly competitive industry. KIL is currently producing at a point where market price equals its marginal cost; KIL’s total revenue is less than its total cost but exceeds its total variable cost. What advice should you provide KIL’s owners?
a. Shut down immediately because it is incurring a loss. b. Reduce prices in order to sell more units of output. c. Raise its price until it breaks even and then begins making profit. d. Continue production in the short run to minimize losses, but exit the industry in the long run.
d. Continue production in the short run to minimize losses, but exit the industry in the long run.
Merrimack Industries sells its output in a perfectly competitive market. Which of the following statements is true about Merrimack?
a. Merrimack faces a downward sloping demand curve. b. Merrimack will earn zero economic profits in long-run equilibrium. c. Merrimack would increase its total economic profits by charging a price slightly lower than the market price. d. The marginal revenue Merrimack receives from selling an additional unit of output will be different from the price at which it sells that unit.
b. Merrimack will earn zero economic profits in long-run equilibrium.
Suppose workers prefer a certain amount of autonomy and flexibility in their job responsibilities. Job A and B are identical in all respects except Job A offers some autonomy and flexibility. Which of the following combinations of annual salaries would you predict?
a. A: $40,000 B: $40,000 b. A: $40,000 B: $50,000 c. A: $50,000 B: $40,000 d. A: $50,000 B: $50,000
b. A: $40,000 B: $50,000
Which of the following types of firm is most likely to be a monopoly?
a. Local restaurant b. Local electricity provider c. Local landscaping services company d. Local pet sitting company
b. Local electricity provider
Charlton Computer Company has a monopoly over the production of a specialized processor. It will be profitable for Charlton to increase production of its specialized processors as long as marginal cost
a. is less than marginal revenue. b. equals marginal revenue. c. is greater than marginal revenue. d. is indifferent.
a. is less than marginal revenue.
National Mfg. Co. (NMC) is a monopoly in the market. Suppose it can sell 4 units of its output at $5.00 per unit and 5 units of its output at $4.90 per unit. NMC will produce and sell the fifth unit if its marginal cost is
a. $5.00 or less. b. $4.90 or less. c. $4.50 or less. d. $4.00 or less.
c. $4.50 or less.
Which of the following statements is true regarding the difference between monopoly prices and quantities compared to perfectly competitive prices and quantities?
a. Monopoly prices and quantities are both lower than in perfect competition. b. Monopoly prices and quantities are both higher than in perfect competition. c. Monopoly prices are lower than prices in perfect competition but quantities are higher than in perfect competition. d. Monopoly prices are higher than prices in perfect competition but quantities are lower than in perfect competition.
d. Monopoly prices are higher than prices in perfect competition but quantities are lower than in perfect competition.
In the long run, which of the following outcomes is most likely for a firm?
Zero accounting profits but positive economic profits
Zero accounting profits
Positive accounting profits and positive economic profits
Zero economic profits but positive accounting profits
Zero economic profits but positive accounting profits
At the individual firm level, which of the following types of firms faces a downward-sloping demand curve?
Both a perfectly competitive firm and a monopoly firm
Neither a perfectly competitive firm nor a monopoly firm
A perfectly competitive firm but not a monopoly firm
A monopoly firm but not a perfectly competitive firm
A monopoly firm but not a perfectly competitive firm
Which of the following types of firms are guaranteed to make positive economic profit?
Both a perfectly competitive firm and a monopoly
Neither a perfectly competitive firm nor a monopoly
A perfectly competitive firm but not a monopoly
A monopoly but not a perfectly competitive firm
Both a perfectly competitive firm and a monopoly
What is the main difference between a competitive firm and a monopoly firm?
The number of customers served by the firm.
Monopoly firms are more efficient and therefore have lower costs.
Monopoly firms can generally earn positive profits over a longer period of time.
Monopoly firms enjoy government protection from competition.
Monopoly firms can generally earn positive profits over a longer period of time.
Which of the following products is closest to operating in a perfectly competitive industry?
Nike shoes
Cotton
Perdue Chicken
Restaurants
Cotton
A firm in a perfectly competitive market (a price taker) faces what type of demand curve?
Unit elastic
Perfectly inelastic
Perfectly elastic
None of the above
Perfectly elastic
A competitive firm’s profit-maximizing price is $15. At , the output is 100 units. At this level of production, average total costs are $12. The firm’s profits are
$300 in the short run and long run.
$300 in the short run and zero in the long run.
$500 in the short run and long run.
$500 in the short run and zero in the long run.
$300 in the short run and zero in the long run.
If a firm in a perfectly competitive industry is experiencing average revenues greater than average costs, in the long run
some firms will leave the industry and price will rise.
some firms will enter the industry and price will rise.
some firms will leave the industry and price will fall.
some firms will enter the industry and price will fall.
some firms will enter the industry and price will fall.
A sudden decrease in the market demand in a competitive industry leads to
losses in the short run and average profits in the long run.
above-average profits in the short run and average profits in the long run.
new firms being attracted to the industry.
demand creating supply.
demand creating supply.
At a university faculty meeting, a proposal was made to increase health care benefits for new faculty to keep pace with the high cost of health care.
True or False:
In the long run, this increase in health care benefits will have no effect on the attractiveness of faculty positions compared to other jobs. (Hint: Consider how the indifference principle applies to this occupation in the long run.)
True
the indifference principle states that, in the long run, if an asset is mobile, then it will be indifferent about where it is used. That is, the asset will earn the same profit no matter where it goes.
When applied to the labor market, the indifference principles implie that wages will adjust to restore equilibrium. In this case, an increase in some nonsalary benefit (such as housing benefits or health care benefits) makes the faculty position more attractive relative to other occupations. However, over the long run, as more people seek to become faculty members, the supply of labor in this occupation will increase, driving down wages in the occupation. At the same time, the supply of labor will decrease in other industries, as individuals in those industries (or individuals who would have entered those industries) seek to become faculty members. Thus, wages in other industries rise.
The wages of new faculty members will continue to fall until faculty jobs are just as attractive as any other job. At this point, there is no incentive for individuals to continue to enter the college teaching profession, and the labor supply for faculty positions will stop increasing. Since the supply of labor has stopped increasing, wages stop decreasing. At this new equilibrium, despite the increase in benefits, wages have adjusted downward so that faculty jobs are equally attractive as other jobs
At a university faculty meeting, a proposal was made to increase health care benefits for new faculty to keep pace with the high cost of health care.
True or False: In the long run, this increase in health care benefits will make faculty positions less attractive than other jobs. (Hint: Consider how the indifference principle applies to this occupation in the long run.)
False
Distributors of beer earn some monopoly profits in their local markets but see them slowly erode as substitutes enter the market. Suppose Nebraska has scheduled a vote on the legalization of marijuana.
Additionally, suppose that marijuana and beer are substitutes and that the legalization of marijuana would lead to a decrease in the price of marijuana.
Given the relationship between marijuana and beer, the legalization of marijuana would lead to ___________ in demand for beer. Thus, distributors of beer would likely __________ the legalization of marijuana.
Decrease
Oppose
(substitutes)
Distributors of snack foods earn some monopoly profits in their local markets but see them slowly erode as substitutes enter the market. Suppose Nebraska has scheduled a vote on the legalization of marijuana. Additionally, suppose that marijuana and snack foods are complements and that the legalization of marijuana would lead to a decrease in the price of marijuana.
Given the relationship between marijuana and snack foods, the legalization of marijuana would lead to _______ in demand for snack foods. Thus, distributors of snack foods would likely _________ the legalization of marijuana.
increase
support
(complements)
Relative to managers in more _______ industries, managers in more ________ industries are more likely to spend their time on pricing strategies rather than on reducing costs.
competitive
monopolistic
Describe the difference in economic profit between a competitive firm and a monopolist in both the short and long run. Which should take longer to reach the long-run equilibrium?
True or False: The adjustment to long-run equilibrium occurs more quickly for monopolists than for competitive industries.
In the short run, both monopolists and competitive firms can earn positive economic profits. In the long run, neither monopolists nor competitive firms can earn a positive economic profit.
False.
Monopolists have no rivals, because they produce a product or service with no close substitutes and enjoy high barriers to entry, which prevent potential competitors from entering the industry. For example, pharmaceutical companies with patents on new drugs are likely to enjoy monopoly power, since a patent ensures that there will be no close substitutes or competitors for a period of time. These barriers to entry and lack of substitute products allow monopolies to earn positive profits in the short run. In the long run, however, even the barriers that protect monopolists in the short run eventually fall; for example, patents expire, and other firms become able to develop close substitutes or invent new products that can compete with the products produced by monopolies. Thus, in the long run, even monopoly economic profit is driven to zero.
By contrast, competitive firms face constant competition from rival firms producing substitute products as well as new firms that are free to enter the industry (due to low barriers to entry). These factors drive any positive economic profits, which may exist in the short run, to zero for all firms in a competitive industry in the long run.
While long-run adjustments drive economic profit to zero in the long run for both competitive industries and monopolies, this adjustment will likely occur more rapidly in competitive industries than in monopolies. This is due in large part to the freedom of entry and exit that is present in a competitive market, causing any positive or negative economic profit to adjust quickly to zero. If there are positive economic profits, firms can quickly enter the industry and drive economic profits to zero. If negative economic profit is present, firms will exit the industry rapidly until economic profit for the remaining firms rises to zero. In the case of monopolies, barriers to entry, such as patents or ownership of natural resources, are more likely to last longer and greatly slow the long-run adjustment to zero economic profit.
