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At what price will there be neither economic profit to attract new firms into the market nor economic loss to drive firms out of the market? At minimum Average Total Cost. In the long run, the price will be equal to minimum Average Total Cost, and the firms will be earning zero economic profit (a normal profit). A graph illustrating perfect competition in the long run is included in an appendix at the end of this chapter. Perfect Competition and Economic Efficiency The basic economic problem is scarcity. The basic goal in dealing with the problem of scarcity is to produce as much consumer satisfaction as possible with the limited resources available. To achieve this goal, society must use its limited resources as efficiently as possible. The concept of the economically efficient level of an activity was introduced in Chapter 1 and was further explained in Chapter 18. In Chapters 1 and 18, we saw that the optimal (ideal, most efficient) level of an activity occurs where the marginal benefit and the marginal cost of the activity are equal. In this chapter, and for the rest of the textbook, we will refer to this economic efficiency rule with slightly altered terminology. Economic efficiency rule – produce the quantity of output where marginal social benefit equals marginal social cost. Marginal social benefit (MSB) is the value (benefit) to society of the marginal unit of output. If there is an external benefit (see Chapter 27), marginal social benefit will be different than marginal private benefit. Assuming no external benefits, marginal social benefit is the same as marginal private benefit and is measured by market price. Marginal social cost (MSC) is the cost to society of producing the marginal unit of output. If there is an external cost (see Chapter 27), marginal social cost will be different than marginal private cost. Assuming no external costs, marginal social cost is the same as marginal private cost and is measured by marginal cost. Thus, if there are no externalities, the ideal (economically efficient) quantity of output occurs where price equals marginal cost. Perfect competition is the ideal (most efficient) market structure because it results in the quantity of output where price equals marginal cost and thus (assuming no externalities) where marginal social benefit equals marginal social cost. Referring back to Example 6C, at the profit-maximizing quantity of six units, price ($10) equals marginal cost ($10), and thus MSB equals MSC. Perfect Competition’s Happy Coincidence A perfect competitor, like any other business firm, has a chief goal of profit-maximization. To achieve this goal, a perfect competitor will produce according to the profit-maximization rule (produce the quantity of output where marginal revenue equals marginal cost). By a happy coincidence, the profit-maximizing quantity of output is also the economically efficient quantity of output (where price equals marginal cost and thus where MSB equals MSC). So the goal of the firm (profit-maximization) and the goal of society (economic efficiency) are both reached at the same quantity of output. This is why perfect competition is the ideal market structure. Perfect Competition and Individual Freedom Another advantage of perfect competition is that perfect competition contributes to individual freedom. In a perfectly competitive market, production and distribution decisions can be made by individuals, not by central authority, thus maximizing individual freedom. Because the goal of the firm (profit-maximization) and the goal of society (economic efficiency) are both reached at the same quantity of output, society can leave perfect competitors alone, free to pursue self-interest. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 21 - 7 Perfect Competition
Appendix: Economic Profit and Economic Loss In Example 6C, the selling price ($10) was above Average Total Cost ($9.50). Percomp Company produced six units of output and earned an economic profit of $3. This is illustrated on the graph below: $13 - 12 - 11 - 10 - Price 9- 8- 7- 6- 5- Z ATC Profit 0 0 1 2 3 4 5 6 7 8 9 Quantity D = P = MR In Example 6D, the selling price ($8) was below Average Total Cost ($9.50). Percomp Company produced four units of output and incurred an economic loss of $6. This is illustrated on the graph below: $13 - 12 - 11 - 10 - Price 9- 8- 7- 6- 5- Z ATC Loss 0 0 1 2 3 4 5 6 7 8 9 Quantity D = P = MR FOR REVIEW ONLY - NOT FOR DISTRIBUTION MC MC Perfect Competition 21 - 8
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PRINCIPLES OF ECONOMICS JEFF HOLT S
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Principles of Economics, 6th Editio
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16. Study Guide for Chapter 7 17. C
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11. Appendix: Book Review - “The
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20. Appendix: The NCAA Cartel 21. S
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Introduction: A Brief History of U.
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In the twentieth century, per capit
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Appendix: The 35 Largest National E
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Multiple Choice: ___ 1. The Jamesto
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2. Describe the economic cost of th
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Chapter 1 Scarcity and Choices The
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Example 5B: At the end of 1982, the
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Example 11: When Cindy quits her jo
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consequences may result in failure
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An upward sloping curve (as in Exam
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In making decisions, humans tend to
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5. ______________________ _________
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___ 13. If the value of one variabl
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Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7
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Chapter 2 Trade and Economic System
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Example 4B: The following quantitie
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1. An increase in the quantity of r
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3. For whom to produce? This is det
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The graph below illustrates the shi
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The two primary economic systems ar
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___ 12. The capitalist vision sees
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___ 25. According to the book “Ca
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Chapter 3 Demand, Supply, and Equil
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. For inferior goods, income and de
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The same information can be placed
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Not only does a free market elimina
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$7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3
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Example 17: The graph below illustr
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Questions for Chapter 3 Fill-in-the
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___ 12. Assuming a market originall
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$8 - 7 - 6 - 5 - Price 4 - 3 - 2 -
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Chapter 4 Inflation and Unemploymen
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Computing the Rate of Inflation The
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Full Employment Though unemployment
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3. Cyclical unemployment - due to d
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During the Great Depression, the ec
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Appendix: Think Like an Economist -
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Answer questions 8. and 9. based on
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___ 25. The extension of unemployme
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Chapter 5 Measuring Total Output: G
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5. Leisure. Leisure time is by defi
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The U.S. is a high per capita GDP c
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Example 17: In “An International
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The simple circular flow diagram be
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___ 3. Which of the following would
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2. Explain what nonproduction trans
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Chapter 6 The Aggregate Market The
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Example 2C: Assume the same facts a
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Example 5B: The price of crude oil
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Price Level Real GDP SRAS AD 2 AD 1
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Appendix: Why the Aggregate Demand
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___ 3. DEF Company can invest in ne
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2. List and explain the two factors
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Chapter 7 Classical Economic Theory
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Notice that the investment demand c
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Long-Run Equilibrium If Real GDP is
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Example 6B: When the economy is in
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Laissez-faire If the economy is sel
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___ 5. According to Say’s Law: a.
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3. On the graph below, draw an aggr
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Chapter 8 Keynesian Economic Theory
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Example 2B: The graph below illustr
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Example 5: Assume that the table be
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Notice on the graph on the previous
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According to Keynesian theory, a ch
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“The General Theory” also inclu
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___ 8. If the consumption function
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3. If the MPC is .667, and investme
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Chapter 9 Fiscal Policy The basic e
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Keynesian Fiscal Policy Theory and
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Example 5A: The federal government
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The Laffer Curve What will happen t
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Appendix: The Importance of Incenti
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___ 4. A decrease in government exp
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2. Explain what automatic stabilize
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Chapter 10 Money, Money Creation, a
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Example 4B: The castaways on Gillig
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Looking at the balance sheet below,
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Demand-side One-shot Inflation Exam
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4. Inflation increases uncertainty
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life; it came into existence not by
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calculated by using the potential d
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___ 12. If the required-reserve rat
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4. Referring to the balance sheet f
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Chapter 11 The Federal Reserve Syst
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5. After Bank X sells the $300,000
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Low Mortgage Interest Rates Mortgag
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Relaxed Standards for Mortgage Loan
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The Bursting of the Housing Bubble
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On February 17, 2009, the federal g
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Fed policies caused short-term inte
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___ 10. The Fed’s most important
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___ 25. In response to the recessio
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Chapter 12 Monetary Policy The basi
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2. A change in aggregate demand (AD
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Monetarist Transmission Mechanism C
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3. Borrowers do not have to seek ou
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Appendix: Book Review - “The Age
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Questions for Chapter 12 Fill-in-th
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___ 16. The primary source of incom
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7. According to Alan Greenspan, wha
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Chapter 13 Taxes, Deficits, and the
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Example 5: In 2015, Taxpayer A had
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of $5 and a quantity of 10 units. T
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The complexity of the tax law also
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the current government spending and
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cut of 1964. The top rate was lower
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___ 6. Federal excise taxes: a. are
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3. How would eliminating the loopho
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Chapter 14 Economic Growth The basi
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2. Labor. Labor can contribute to e
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estricting international trade (e.g
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An improvement in technology (e.g.
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The table below shows the economic
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will increase both Real GDP and per
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___ 8. Which of the following is co
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___ 26. The opinion that economic g
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Chapter 15 Less Developed Countries
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Example 8: Countries A, B, C, and D
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Obstacles to Economic Development f
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c. Restrictions on international tr
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Appendix: Book Review - “The Powe
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Example 25: In Brazil, about half t
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Study Guide for Chapter 15 Chapter
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___ 13. Among the counterproductive
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4. List four ways that governments
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Chapter 16 International Trade The
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Other Benefits of Free Internationa
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Example 6: The graph below illustra
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competitive disadvantage. But dumpi
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is only 25% as productive as before
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Smith was skeptical of government a
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___ 4. For Country X, what is the o
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___ 18. Frédéric Bastiat’s “P
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4. On the graph below: (1) What is
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Chapter 17 Elasticity We are often
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Example 4A: What is price elasticit
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Example 5A: Gertie’s Gas and Go i
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Example 10A: When the price of Good
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Example 13B: On the graph below, su
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$7 - 6 - 5 - Price 4 - 3 - 2 - 1 -
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In the long run, would the deadweig
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___ 7. The factors that determine w
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3. a. Which price (or prices) from
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Chapter 18 Utility The basic econom
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Page 304 and 305: Example 9: Capital City operates a
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Page 318 and 319: 1. Difficulty in raising large amou
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Page 322 and 323: Example 24: A blacksmith who produc
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Page 330 and 331: Chapter 20 Production and Costs The
Page 332 and 333: In Example 5B, Birdwell finds that
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Page 336 and 337: Quantity TC MC AFC AVC ATC 0 240 X
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Page 340 and 341: average total cost. Average fixed c
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Page 346 and 347: Chapter 21 Perfect Competition The
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Page 362 and 363: Chapter 22 Monopoly Of the four mar
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Page 378 and 379: Chapter 23 Monopolistic Competition
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Page 384 and 385: Example 9: The Organization of the
Page 386 and 387: Example 12 illustrates the dilemma
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Page 390 and 391: ___ 14. Game theory: a. is a method
Page 392 and 393: Answers for Chapter 23 Fill-in-the-
Page 394 and 395: Chapter 24 Factor Markets The basic
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were his strikeouts, walks, and hom
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___ 3. To maximize profits, a produ
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___ 19. According to the book, “M
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Multiple Choice: 1. a. 8. c. 15. d.
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Chapter 25 Labor Unions The primary
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The elasticity of demand for union
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Example 4A: Assume that the graph b
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Notice from the graph in Example 6
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Wage Factory A Quantity of Labor S
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As a cartel, a labor union faces a
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___ 10. For a monopsony: a. there i
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3. The graph below represents a lab
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Chapter 26 Interest, Present Value,
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An increase in expected rates of re
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An asset is valuable because we exp
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Example 13B: General Ordnance prove
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Appendix: Present Value Table One f
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___ 4. An increase in expected rate
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Problems: 1. List and explain the t
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Chapter 27 Market Failure The basic
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External Benefit If a market genera
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Example 2: To encourage the consump
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$100 - 90 - 80 - MSC 70 - $ 60 - 50
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A common good is nonexcludable. Non
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___ 5. What government policy would
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4. Based on the information on the
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Chapter 28 Public Choice and Govern
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Candidates and the Median Voter Mod
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Example 8: According to State and F
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Example 10: When Elvis Presley was
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4. Pessimistic bias. This is the te
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___ 5. An elected official will: a.
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2. If a certain policy will yield s
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Chapter 29 Government Regulation of
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underproduction is the amount that
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micromanagement results in business
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market. They may agree with their c
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Questions for Chapter 29 Fill-in-th
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___ 10. The public interest theory
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4. List the four types of costs imp
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Chapter 30 Agriculture and Health C
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weather may cause bumper crops. Bad
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Security and Rural Investment Act o
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Example 12: From 1960 to 2013, the
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1. NHI would provide universal heal
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d. Insurance providers are not allo
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Answer questions 7. through 10. by
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___ 21. If there were no individual
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Chapter 31 Income Distribution and
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Income is more equally distributed
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over a typical career is the accumu
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Ideal Income Redistribution The ide
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Poverty - a family whose income fal
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Appendix: Income Inequality around
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How is this story an analogy for th
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___ 2. In 2013, the Lowest Income 6
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Problems: 1. Explain the two primar
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Absolute advantage - when one natio
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Fiat money - money by government de
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Nonrivalrous good - a good for whic
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Absolute advantage, 16-9 Absolute e
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“Company town”, 25-6 Comparativ
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Eli Lilly and Company, 22-1 Emergen
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Houston, Texas, 15-10 Human capital
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Market, 3-1, 3-8-9 Market basket, 4
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Political bias, 9-4, 12-7 Political
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Short run production, 20-2-3 Short-
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Upturns, 9-4 USDA, 27-9, 30-1-2, 30
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