ECO401 Flashcards
Q: What are the two types of efficiency achieved under perfect competition in the long run?
A: Allocative efficiency (P=MC) and productive efficiency (P=minimum AC).
Q: Why can monopolies earn supernormal profits even in the long run?
A: Barriers to entry prevent new firms from entering the market, allowing monopolies to maintain high prices.
Q: What is the key difference between the demand curve in perfect competition and monopoly?
A: Perfect competition has a horizontal (infinitely elastic) demand curve, while a monopoly faces a downward-sloping demand curve.
Q: Define “limit pricing” in the context of monopolies.
A: A strategy where a monopolist sets prices below potential entrants’ average costs to deter new competitors.
Q: What are the three conditions required for price discrimination?
A: Market segmentation, different price elasticities of demand among groups, and no arbitrage between markets.
Q: How does third-degree price discrimination differ from first-degree?
A: Third-degree charges different prices to distinct market segments (e.g., students vs. adults), while first-degree charges each consumer their maximum willingness to pay.
Q: Why is the kinked demand curve model used to explain price rigidity in oligopolies?
A: Firms assume rivals will match price cuts but ignore price hikes, creating a “kink” where demand becomes inelastic below and elastic above the current price.
Q: What is the Nash equilibrium in the Prisoner’s Dilemma?
A: Both prisoners betray each other, resulting in a suboptimal outcome (5-year sentences) despite mutual cooperation being better.
Q: How does a natural monopoly arise?
A: Due to economies of scale, where a single firm can supply the entire market at a lower cost than multiple firms.
Q: What is the primary difference between GDP and GNP?
A: GDP measures output within a country’s borders, while GNP includes income earned abroad by citizens and excludes income earned domestically by foreigners.
Q: Name two drawbacks of using GDP to measure welfare.
A: Excludes non-market activities (e.g., household work) and ignores environmental degradation and income inequality.
Q: What is the “invisible hand” concept by Adam Smith?
A: The idea that individuals pursuing self-interest in free markets unintentionally benefit society through efficient resource allocation.
Q: How did Keynes explain persistent unemployment during the Great Depression?
A: Wage rigidity and pessimistic expectations led to insufficient aggregate demand, trapping the economy below full employment.
Q: Contrast classical and Keynesian views on aggregate supply.
A: Classical: AS is vertical at full employment. Keynesian: AS is horizontal (recession) or upward-sloping (near full capacity).
Q: What causes the backward-bending labor supply curve?
A: At high wage levels, the income effect (preferring leisure over work) dominates the substitution effect (working more for higher wages).
Q: Define “externality” and give an example of a negative production externality.
A: Externality: Uncompensated impact on third parties. Example: Pollution from a factory affecting nearby residents.
Q: Why are public goods non-excludable and non-rivalrous?
A: Non-excludable: Cannot prevent non-payers from using (e.g., national defense). Non-rivalrous: One person’s use doesn’t reduce availability (e.g., streetlights).
Q: What is the free-rider problem?
A: Individuals benefit from public goods without contributing, leading to under-provision in private markets.
Q: How does the government correct for a positive consumption externality?
A: Subsidize the good (e.g., education) to align marginal social benefit with marginal private benefit.
Q: What is the formula for the value of marginal product of labor (VMPL)?
A: VMPL = Marginal Physical Product of Labor (MPPₗ) × Price of the output (P).
Q: Explain the “crowding out” effect of fiscal policy.
A: Government borrowing raises interest rates, reducing private investment due to higher borrowing costs.
Q: What is stagflation, and why did it challenge Keynesian economics?
A: Simultaneous high inflation and unemployment (1970s oil shocks). Keynesian policies couldn’t address supply-side causes.
Q: What does the GDP deflator measure?
A: The ratio of nominal GDP to real GDP, reflecting inflation across all goods/services in the economy.
Q: Why is purchasing power parity (PPP) used for cross-country income comparisons?
A: Adjusts for price differences, showing real purchasing power of income in different countries.
