ch 7 efficiency, exchange, and the invisible hand in action

invisible hand

individuals act in their own interests

aggregate outcome is collective well-being

profit motive

produce highly valued goods and services

allocate resources to their highest value use

ex: taylor swift doesn’t wait tables

accounting profit

total revenue - explicit costs

explicit costs

payments firms make to purchase

resources and products from other firms

economic profit

difference between a firm’s total revenue and the sum of its explicit and implicit costs

total revenue - explicit costs - implicit costs

firms that earn positive _______ recover more than their opportunity cost

implicit costs

opportunity costs of the resources supplied by the firm’s owners

normal profit

difference between accounting profit and economic profit

keep the resources in their current use

firms that earn ______ recover only their opportunity cost

rationing function of price

distributes scarce goods to the consumers who value them most highly

allocative function of price

directs resources away from overcrowded markets to markets that are underserved

invisible hand theory

actions of independent, self-interested buyers and sellers will often result in the most efficient allocation of resources

attract

markets with excess profits ______ resources

supply increases and shifts to right; decrease equilibrium price

as new firms enter, _______

supply shifts to the left; increases equilibrium price

as firms leave, _______

long run equilibrium

when economic profits are exactly zero

a market has no new firms enter or leave

barrier to entry

any force that prevents firms from entering a new industry

ex: legal constraints, practical factors

economic rent

portion of a payment to a factor of production that exceeds the owner’s reservation price

competitive markets

with _______, equilibrium leaves no opportunities for individuals to make great gains

non-equilibrium opportunities

_______ benefits individuals

no cash on the table

all opportunities have been exhausted, market is in long run equilibrium

sellers’ marginal costs

buyers’ marginal benefits = ?

society’s marginal benefits

= society’s marginal costs

buyer’s or consumer surplus

buyer’s reservation price - market price

seller’s or producer surplus

market price - seller’s reservation price

total surplus

buyer’s (consumer) surplus + seller’s (producer) surplus

buyer’s reservation price - seller’s reservation price

efficient/socially optimal

market allocation (price/quantity combination in a market) is ________ if total surplus is maximized

consumer surplus

• difference between the buyer’s reservation price and the market price

• reservation price is on the demand curve

• the economic surplus buyers receive from consuming the good

• area below demand curve and above market price

producer surplus

• difference between the market price and the seller’s reservation price

• reservation price is on the supply curve

• the economic surplus sellers receive from producing the good

• area above supply curve and below market price

socially optimal quantity

maximizes total surplus for the economy from producing and selling a good

efficiency principle

equilibrium price and quantity are efficient if

• sellers pay all the costs of production

• buyers receive all the benefits of their purchase

efficiency

marginal cost = marginal benefit

production is _____ if total surplus is maximized

price ceiling

• maximum allowable price, specified by law

• if binding, can lead to excess demand

deadweight loss

total economic surplus lost = ?