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Microeconomics Chapter 9-Part 1-book notes

question
This chapter examines the successes and the failures of competitive markets and how with such markets the producer is, to use the words of Adam Smith, "led by an invisible hand to promote an end which was no part of his intention."1
answer
...
question
Out of this comes the concept of efficiency, which we define and explain. We look at some of the other benefits of competition and then examine various situations in which competitive markets fail.
answer
...
question
Finally, we look at the reasons for the failure and explore some of the ways that these problems can be addressed, either through government intervention or by helping the market find its own solutions.
answer
...
question
We saw, in Chapter 8, how competitive firms react to changes in prices and profitability. Each change causes an adjustment by the firm and by the whole industry as well. This chapter will continue to examine this theme of adjustment and will evaluate the results.
answer
...
question
9.1HOW COMPETITIVE MARKETS ADJUST TO LONG-RUN CHANGES
LO1 Explain how perfectly competitive markets encourage technological improvement and growth in the size of firms.
answer
...
question
We begin this chapter by looking at how they adjust to long-run changes, such as technological change and the growth in the size of firms.
answer
...
question
If an industry, or an economy, is to grow and prosper, its environment must encourage and stimulate innovation. Let us see how well perfect competition encourages change by looking at how it accommodates the most economically important type of change: technological change.
answer
...
question
Suppose that Bobby Brewer discovers an improved brewing method that speeds up the fermentation process by 50 percent so that beer can now be produced more quickly and therefore more cheaply. The result for Bobby will be higher profits.
answer
...
question
Will the other brewers (assuming there are no patent laws) be inclined to introduce this new process? Some will, and some will not.
answer
...
question
he whole industry will start to grow. However, the result of this influx of new brewers is a long-run increase in supply and a resulting decline in price.
answer
...
question
And what will happen to the older breweries that did not introduce Bobby's new technology? Faced with a fall in the price, they will be forced to introduce it; if not, their accumulating losses will force their exit from the industry. Eventually, only firms that use the new process will survive.
answer
...
question
Producers in competitive markets are therefore forced to be innovative; if they are not, competition from new, more progressive firms will force them to change or go the way of the dodo.
answer
...
question
n Chapter 8, we observed that in the short run, an increase in demand increases both the price and the profitability of the representative firm. This will stimulate the firm to increase production. If the firm believes that the industry is likely to remain a high-demand and high-profit industry, it will be encouraged to grow in size, especially if this leads to economies of scale.
answer
Suppose that a firm is operating out of plant 1 and the present market price is P1. The profit-maximizing output in this case will be quantity Q1, where, in fact, the firm is just breaking even. However, if we assume that there are economies of scale to be obtained in this industry, it will pay the firm to move to a bigger plant, such as plant 2, and increase its level of production to Q2 (where P = MC) and thereby earn economic profits.
question
In the long run, competitive firms will not make economic profits.
answer
...
question
Suppose that the price of the product is initially at P1 and the average firm's cost curves are shown as AC1 and MC1 in Figure 9.2. In the short-run, the firm is making only normal profits; that is, it is breaking even. However, higher profits can be made through growth because economies of scale can be obtained. This will cause the representative firm to move into bigger plants, such as plant 2, and since other firms will do the same, the price will drop as the industry supply increases. As this firm and others grow in size, their costs drop—and so does the price. In time, the eventual price of the product will drop to price P2 in Figure 9.2.
answer
...
question
As we saw, over a period, competitive firms will tend to grow in size if there are economies of scale to be obtained. This causes the price to drop and economic profits to be squeezed out. When the typical firm in this industry has grown to plant size 3, it will have no further incentive to grow because plants bigger than plant size 3 will experience diseconomies of scale. For plant size 3, the optimum output will be Q3. The two forces combined—firms growing in size and falling market price—will result in the typical firm producing an output of Q3 in a plant of size 3 in Figure 9.3 and the price level settling at P3.
answer
...
question
This leads to a very important conclusion:
In the long run, in perfectly competitive markets, equilibrium price will be equal to the firm's long- and short-run average costs (both of which are at their minimums) and also to the marginal cost.
answer
...
question
Self-Test 9.1
answer
...
question
Self-Test 9.1 Answer Key
answer
...
question
9.2THE BENEFITS OF PERFECT COMPETITION
LO2 Explain the benefits of perfectly competitive markets.
answer
...
question
We have already seen one of the major benefits of perfectly competitive markets: they encourage innovation by offering the reward of short-term economic profits.
answer
...
question
In addition to encouraging innovation, perfect competition forces firms to be both productively and allocatively efficient.
answer
...
question
Concentrating on the average costs in Figure 9.3 for a moment, we can see that in the long run, the firm will produce at the point where price equals short-run average cost and long-run average cost.
answer
...
question
This conclusion illustrates the concept of productive efficiency which is the production of an output at the lowest possible average cost.
answer
...
question
This means that a product is being produced at the lowest possible average cost, that is, in the most efficient plant size and at the most efficient output level for that particular plant size.
answer
...
question
Furthermore, customers are the main beneficiaries of this because they are paying a price just equal to this lowest possible average cost. This means that the firms are making normal profits only.
answer
...
question
Productive efficiency is where P = minimum AC.
answer
...
question
Productive efficiency is one way in which economists try to evaluate all forms of markets. They ask: does this particular system result in goods and services being produced at their lowest costs, and does the price of the product reflect that cost?
answer
...
question
There is a second, equally important, test of how well a market performs, and that is to ask: are consumers, given their tastes and incomes, getting the products that they want?
answer
...
question
In other words, is the best possible bundle of goods being produced?
answer
...
question
A vegan society that produced lots of beef or pork would hardly be considered efficient, even if these things were produced at the lowest cost possible. On the other hand, a society that takes into consideration the tastes of people (as well as their incomes and the capabilities of the economy) is said to possess allocative efficiency.
answer
In Figure 9.4A, we see the typical firm in long-run equilibrium at an output of 400 that minimizes both short-run and long-run average costs and P = MC = $6. In Figure 9.4B, we see the market outcome after summing up the marginal cost curves of each firm to get the market supply curve and adding the market demand curve. The market equilibrium price is $6, and quantity is 3000.
question
Allocative efficiency means that the very best allocation of resources and products has been achieved. If this is the case, then no other combination of products would achieve a better result for society.
answer
...
question
What the market needs to do is, in a sense, weigh the cost of using the resources in a particular way against the satisfaction that the resulting products yield.
answer
...
question
This means that the marginal cost of production should, in some sense, be measured against the marginal utility from consumption.
answer
...
question
Allocative efficiency implies, then, not only the maximization of consumers' utility but also the maximization of producers' profits. And it also means:
Allocative efficiency occurs where P = MC.
answer
...
question
In short, allocative efficiency balances the tastes and incomes of consumers against the availability of the economy's resources.
answer
...
question
What perfectly competitive markets do is adjust production and consumption among different products until no further gain could accrue to either producers or consumers from any other combination of goods. This is the essence of productive and allocative efficiency and is a major characteristic of perfectly competitive markets. Figure 9.4 illustrates this outcome.
answer
five
question
Figure 9.4A shows that in a perfectly competitive environment the typical firm produces an output where both short-run and long-run costs are at a minimum and price equals marginal costs.
answer
failures
question
The summation of each firm's marginal cost curve gives us the market supply curve in Figure 9.4B. When we add the market demand curve, we get the equilibrium price of $3 and an equilibrium quantity of 3000 as determined by the interaction of supply and demand.
answer
defects
question
The dark shaded triangle in Figure 9.4B above the price line but below the demand curve represents consumer surplus, as we discussed in Chapter 5. It is the difference between what consumers are willing to pay and actual price of the product.
answer
guarantor
question
In a very similar sense, the light shaded triangle represents producer surplus, since producers received a price for each unit supplied, up until the very last one, which exceeds the amount that they would be willing to accept.
answer
unstable
question
Therefore, another way of thinking of productive and allocative efficiency is to realize that it means that consumer and producer surplus has been maximized. The addition of consumer and producer surplus gives us what economists call economic surplus.
answer
admit
question
In summary, we can say that in the long run perfectly competitive markets produce an output of goods:
from the most efficient plant size for their industry (lowest LRAC) at the most efficient output level for that particular plant size (lowest SRAC). The significance of this is that both productive and allocative efficiencies have been achieved and economic surplus has been maximized.
answer
ensure
question
Productive efficiency and allocative efficiency are the two main standards by which economists try to evaluate markets, but they are not the only benefits that result from competition.
answer
overproduction, externalities
question
Another advantage that the market system (whether competitive or not) has over a planned economy is that markets are a collection of the interaction of millions of producer and consumer decisions happening all at once. There is no one coordinating them and no government organization framing them. That is, the system is automatic and is free of expensive administrative costs. In this sense, the system is costless.
answer
...
question
We also need to add the intuitive argument that perfect competition encourages innovation. It is not hard to imagine active, energetic business people who continuously try to break out of the market constraints of normal profits by introducing innovative, cost-cutting techniques (shifting both the MC and the AC curves down).
answer
undesirable
question
The four strengths of the perfectly competitive market system:
it maximizes economic surplus because both productive and allocative efficiency is achieved.
it does this automatically (is costless).
it encourages innovation.
it promotes economic freedom.
answer
...
question
Self-Test 9.2
answer
...
question
Self-test 9.2 answer key
answer
undefined
question
9.3MARKET FAILURES
LO3 Understand the f___reasons why perfect competition might fail to achieve desirable results.
answer
undefined
question
The remainder of the chapter will examine some of these criticisms, called market f_________. We will look at five types of market failures.
answer
undefined
question
Market failures: are d_________ in competitive markets that prevent them from achieving an efficient or equitable allocation of resources.
answer
undefined
question
First, it is said that the market is no g__________ of fairness, and income and wealth inequalities often seem endemic to competitive markets.
answer
undefined
question
Second, competitive markets are often u_________and periodically seem to move, without warning, from an expansionary boom to a recessionary slump.
answer
undefined
question
Third, competitive markets seem to contain the seeds of their own destruction because they easily a______ forces that work to destroy competition.
answer
undefined
question
Fourth, competitive markets do not e_______ the production of a number of important goods and services known as public goods.
answer
undefined
question
Finally, competitive markets often encourage the o______________ of some products and the underproduction of other products because the market has difficulty in integrating what are known as e_______________.
answer
undefined
question
Income and Wealth Inequalities-Critics of competitive markets point out that allocative efficiency, does not guarantee fairness.
answer
undefined
question
If the income distribution were to change in ways that most consider u___________, the competitive market system would automatically adjust the allocation of resources so as to make the new allocation also efficient.
answer
undefined
question
The competitive market system does not always guarantee that rewards are commensurate with the amount of effort expended.
answer
undefined
question
Instability of Competitive Markets-
answer
undefined
1 of 61
question
This chapter examines the successes and the failures of competitive markets and how with such markets the producer is, to use the words of Adam Smith, "led by an invisible hand to promote an end which was no part of his intention."1
answer
...
question
Out of this comes the concept of efficiency, which we define and explain. We look at some of the other benefits of competition and then examine various situations in which competitive markets fail.
answer
...
question
Finally, we look at the reasons for the failure and explore some of the ways that these problems can be addressed, either through government intervention or by helping the market find its own solutions.
answer
...
question
We saw, in Chapter 8, how competitive firms react to changes in prices and profitability. Each change causes an adjustment by the firm and by the whole industry as well. This chapter will continue to examine this theme of adjustment and will evaluate the results.
answer
...
question
9.1HOW COMPETITIVE MARKETS ADJUST TO LONG-RUN CHANGES
LO1 Explain how perfectly competitive markets encourage technological improvement and growth in the size of firms.
answer
...
question
We begin this chapter by looking at how they adjust to long-run changes, such as technological change and the growth in the size of firms.
answer
...
question
If an industry, or an economy, is to grow and prosper, its environment must encourage and stimulate innovation. Let us see how well perfect competition encourages change by looking at how it accommodates the most economically important type of change: technological change.
answer
...
question
Suppose that Bobby Brewer discovers an improved brewing method that speeds up the fermentation process by 50 percent so that beer can now be produced more quickly and therefore more cheaply. The result for Bobby will be higher profits.
answer
...
question
Will the other brewers (assuming there are no patent laws) be inclined to introduce this new process? Some will, and some will not.
answer
...
question
he whole industry will start to grow. However, the result of this influx of new brewers is a long-run increase in supply and a resulting decline in price.
answer
...
question
And what will happen to the older breweries that did not introduce Bobby's new technology? Faced with a fall in the price, they will be forced to introduce it; if not, their accumulating losses will force their exit from the industry. Eventually, only firms that use the new process will survive.
answer
...
question
Producers in competitive markets are therefore forced to be innovative; if they are not, competition from new, more progressive firms will force them to change or go the way of the dodo.
answer
...
question
n Chapter 8, we observed that in the short run, an increase in demand increases both the price and the profitability of the representative firm. This will stimulate the firm to increase production. If the firm believes that the industry is likely to remain a high-demand and high-profit industry, it will be encouraged to grow in size, especially if this leads to economies of scale.
answer
Suppose that a firm is operating out of plant 1 and the present market price is P1. The profit-maximizing output in this case will be quantity Q1, where, in fact, the firm is just breaking even. However, if we assume that there are economies of scale to be obtained in this industry, it will pay the firm to move to a bigger plant, such as plant 2, and increase its level of production to Q2 (where P = MC) and thereby earn economic profits.
question
In the long run, competitive firms will not make economic profits.
answer
...
question
Suppose that the price of the product is initially at P1 and the average firm's cost curves are shown as AC1 and MC1 in Figure 9.2. In the short-run, the firm is making only normal profits; that is, it is breaking even. However, higher profits can be made through growth because economies of scale can be obtained. This will cause the representative firm to move into bigger plants, such as plant 2, and since other firms will do the same, the price will drop as the industry supply increases. As this firm and others grow in size, their costs drop—and so does the price. In time, the eventual price of the product will drop to price P2 in Figure 9.2.
answer
...
question
As we saw, over a period, competitive firms will tend to grow in size if there are economies of scale to be obtained. This causes the price to drop and economic profits to be squeezed out. When the typical firm in this industry has grown to plant size 3, it will have no further incentive to grow because plants bigger than plant size 3 will experience diseconomies of scale. For plant size 3, the optimum output will be Q3. The two forces combined—firms growing in size and falling market price—will result in the typical firm producing an output of Q3 in a plant of size 3 in Figure 9.3 and the price level settling at P3.
answer
...
question
This leads to a very important conclusion:
In the long run, in perfectly competitive markets, equilibrium price will be equal to the firm's long- and short-run average costs (both of which are at their minimums) and also to the marginal cost.
answer
...
question
Self-Test 9.1
answer
...
question
Self-Test 9.1 Answer Key
answer
...
question
9.2THE BENEFITS OF PERFECT COMPETITION
LO2 Explain the benefits of perfectly competitive markets.
answer
...
question
We have already seen one of the major benefits of perfectly competitive markets: they encourage innovation by offering the reward of short-term economic profits.
answer
...
question
In addition to encouraging innovation, perfect competition forces firms to be both productively and allocatively efficient.
answer
...
question
Concentrating on the average costs in Figure 9.3 for a moment, we can see that in the long run, the firm will produce at the point where price equals short-run average cost and long-run average cost.
answer
...
question
This conclusion illustrates the concept of productive efficiency which is the production of an output at the lowest possible average cost.
answer
...
question
This means that a product is being produced at the lowest possible average cost, that is, in the most efficient plant size and at the most efficient output level for that particular plant size.
answer
...
question
Furthermore, customers are the main beneficiaries of this because they are paying a price just equal to this lowest possible average cost. This means that the firms are making normal profits only.
answer
...
question
Productive efficiency is where P = minimum AC.
answer
...
question
Productive efficiency is one way in which economists try to evaluate all forms of markets. They ask: does this particular system result in goods and services being produced at their lowest costs, and does the price of the product reflect that cost?
answer
...
question
There is a second, equally important, test of how well a market performs, and that is to ask: are consumers, given their tastes and incomes, getting the products that they want?
answer
...
question
In other words, is the best possible bundle of goods being produced?
answer
...
question
A vegan society that produced lots of beef or pork would hardly be considered efficient, even if these things were produced at the lowest cost possible. On the other hand, a society that takes into consideration the tastes of people (as well as their incomes and the capabilities of the economy) is said to possess allocative efficiency.
answer
In Figure 9.4A, we see the typical firm in long-run equilibrium at an output of 400 that minimizes both short-run and long-run average costs and P = MC = $6. In Figure 9.4B, we see the market outcome after summing up the marginal cost curves of each firm to get the market supply curve and adding the market demand curve. The market equilibrium price is $6, and quantity is 3000.
question
Allocative efficiency means that the very best allocation of resources and products has been achieved. If this is the case, then no other combination of products would achieve a better result for society.
answer
...
question
What the market needs to do is, in a sense, weigh the cost of using the resources in a particular way against the satisfaction that the resulting products yield.
answer
...
question
This means that the marginal cost of production should, in some sense, be measured against the marginal utility from consumption.
answer
...
question
Allocative efficiency implies, then, not only the maximization of consumers' utility but also the maximization of producers' profits. And it also means:
Allocative efficiency occurs where P = MC.
answer
...
question
In short, allocative efficiency balances the tastes and incomes of consumers against the availability of the economy's resources.
answer
...
question
What perfectly competitive markets do is adjust production and consumption among different products until no further gain could accrue to either producers or consumers from any other combination of goods. This is the essence of productive and allocative efficiency and is a major characteristic of perfectly competitive markets. Figure 9.4 illustrates this outcome.
answer
five
question
Figure 9.4A shows that in a perfectly competitive environment the typical firm produces an output where both short-run and long-run costs are at a minimum and price equals marginal costs.
answer
failures
question
The summation of each firm's marginal cost curve gives us the market supply curve in Figure 9.4B. When we add the market demand curve, we get the equilibrium price of $3 and an equilibrium quantity of 3000 as determined by the interaction of supply and demand.
answer
defects
question
The dark shaded triangle in Figure 9.4B above the price line but below the demand curve represents consumer surplus, as we discussed in Chapter 5. It is the difference between what consumers are willing to pay and actual price of the product.
answer
guarantor
question
In a very similar sense, the light shaded triangle represents producer surplus, since producers received a price for each unit supplied, up until the very last one, which exceeds the amount that they would be willing to accept.
answer
unstable
question
Therefore, another way of thinking of productive and allocative efficiency is to realize that it means that consumer and producer surplus has been maximized. The addition of consumer and producer surplus gives us what economists call economic surplus.
answer
admit
question
In summary, we can say that in the long run perfectly competitive markets produce an output of goods:
from the most efficient plant size for their industry (lowest LRAC) at the most efficient output level for that particular plant size (lowest SRAC). The significance of this is that both productive and allocative efficiencies have been achieved and economic surplus has been maximized.
answer
ensure
question
Productive efficiency and allocative efficiency are the two main standards by which economists try to evaluate markets, but they are not the only benefits that result from competition.
answer
overproduction, externalities
question
Another advantage that the market system (whether competitive or not) has over a planned economy is that markets are a collection of the interaction of millions of producer and consumer decisions happening all at once. There is no one coordinating them and no government organization framing them. That is, the system is automatic and is free of expensive administrative costs. In this sense, the system is costless.
answer
...
question
We also need to add the intuitive argument that perfect competition encourages innovation. It is not hard to imagine active, energetic business people who continuously try to break out of the market constraints of normal profits by introducing innovative, cost-cutting techniques (shifting both the MC and the AC curves down).
answer
undesirable
question
The four strengths of the perfectly competitive market system:
it maximizes economic surplus because both productive and allocative efficiency is achieved.
it does this automatically (is costless).
it encourages innovation.
it promotes economic freedom.
answer
...
question
Self-Test 9.2
answer
...
question
Self-test 9.2 answer key
answer
undefined
question
9.3MARKET FAILURES
LO3 Understand the f___reasons why perfect competition might fail to achieve desirable results.
answer
undefined
question
The remainder of the chapter will examine some of these criticisms, called market f_________. We will look at five types of market failures.
answer
undefined
question
Market failures: are d_________ in competitive markets that prevent them from achieving an efficient or equitable allocation of resources.
answer
undefined
question
First, it is said that the market is no g__________ of fairness, and income and wealth inequalities often seem endemic to competitive markets.
answer
undefined
question
Second, competitive markets are often u_________and periodically seem to move, without warning, from an expansionary boom to a recessionary slump.
answer
undefined
question
Third, competitive markets seem to contain the seeds of their own destruction because they easily a______ forces that work to destroy competition.
answer
undefined
question
Fourth, competitive markets do not e_______ the production of a number of important goods and services known as public goods.
answer
undefined
question
Finally, competitive markets often encourage the o______________ of some products and the underproduction of other products because the market has difficulty in integrating what are known as e_______________.
answer
undefined
question
Income and Wealth Inequalities-Critics of competitive markets point out that allocative efficiency, does not guarantee fairness.
answer
undefined
question
If the income distribution were to change in ways that most consider u___________, the competitive market system would automatically adjust the allocation of resources so as to make the new allocation also efficient.
answer
undefined
question
The competitive market system does not always guarantee that rewards are commensurate with the amount of effort expended.
answer
undefined
question
Instability of Competitive Markets-
answer
undefined
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