Chapter 9 (Week 5) Flashcards
The need to maximise profit
In a competitive market with identical firms and free entry, if most firms are profit-maximizing, profits are driven to zero at the long-run equilibrium.
Any firm that does not maximize profit will lose money. Thus, to survive in a competitive market, a firm must maximise its profit.
Market failure
Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers
- Lack of information
- Externalities
Cost inefficiency or allocative inefficiency
Deadweight loss
Net loss of total surplus
The value of all transactions that could have been made
Reflects market failure
1/2 x (Pm - Pc) x (Qm - Qc)
Pm: price in a monopoly
Pc: price in a competitive market
Qm: quantity in a monopoly
Qc: quantity in a competitive market
Economic efficiency
Maximisation of aggregate consumer and producer surplus
Externality
Action taken by either a producer or a consumer which affects other producers or consumers but it isn’t accounted for by the market price
Price support
The government buys excess supply in order to artificially inflate prices, so that P goes up - demand drops
Consumer welfare from a good
The benefit a consumer gets from consuming that good minus what the consumer paid to buy the good.
Marginal willingness to pay
A consumer’s marginal willingness to pay: the maximum amount a consumer will spend for an extra unit of a good
A consumer’s marginal willingness to pay is the marginal value the consumer places on the last unit of output.
Consumer surplus
The monetary difference between what a consumer is willing to pay for the good purchased and the good’s price is called consumer surplus (CS).
As price increases, consumer surplus falls
Effect of a price change on consumer surplus
If the supply curve shifts upward or a government imposes a new sales tax, the equilibrium price rises, reducing consumer surplus.
Producer surplus
The difference between the amount for which a good sells and the minimum amount necessary for the seller to be willing to produce the good
As price increases, producer surplus increases
Producer surplus formula
PS = R - VC
Welfare
W = CS + PS
Entry barrier
Raising entry costs shift the supply curve to the left
If a potential firm faces a large entry cost, it might not enter the market, even if existing firms are making profits
Long run barrier to entry: an explicit restriction or a cost that applies only to potential new firms –> existing firms aren’t subject to the restriction or don’t bear the cost
Welfare effects of a tax
Decreases welfare
Welfare effects of a subsidy
increases welfare
