Market Structures, Business Cycles and Fiscal Policy – Key Concepts

70 flashcards covering key concepts from market structures, business cycles, credit cycles and fiscal policy, formatted as question-and-answer pairs for efficient exam practice.

What is the slope of the demand curve faced by a perfectly competitive firm?

Perfectly horizontal (perfectly elastic) at the market price.

Under perfect competition, how does marginal revenue (MR) compare with price (P)?

MR equals price.

Why is MR less than price for firms with market power?

Because they face a downward-sloping demand curve and must lower price to sell additional units.

Define economic profit.

Total revenue minus total economic cost (which includes opportunity costs).

What are sunk costs?

Costs that cannot be avoided even if production ceases; they should be ignored in shutdown decisions.

Shutdown rule when all fixed costs are sunk?

Shut down if market price falls below minimum average variable cost (AVC).

Define economies of scale.

Falling long-run cost per unit as output increases.

Define diseconomies of scale.

Rising long-run cost per unit as output increases.

What is minimum efficient scale?

The output level at the minimum point of the long-run average cost (LRAC) curve.

List the four basic market structures.

Perfect competition, monopolistic competition, oligopoly, monopoly.

Key product characteristic of monopolistic competition?

Product differentiation.

Main feature distinguishing oligopoly from other imperfect markets?

Strategic interdependence among a few sellers.

In perfect competition, what is long-run economic profit?

Zero (normal profit).

Why do concentration ratios and HHI exist?

To approximate the degree of market power when elasticities are hard to measure.

Formula for Herfindahl–Hirschman Index (HHI).

Sum of the squared market shares (as decimals) of the top N firms.

Cournot model assumption about rivals’ output?

Each firm believes rivals will hold output constant when it changes its own output.

What is a kinked demand curve intended to explain?

Price rigidity in non-collusive oligopoly because rivals match price cuts but not price increases.

Define Nash equilibrium in oligopoly pricing.

A set of strategies where no firm can increase profit by unilaterally changing its own price/output.

Dominant firm price leadership implies what behaviour for smaller firms?

They become price followers, selling the residual demand at the leader’s price.

Key difference between business cycle growth cycle and classical cycle.

Growth cycle measures deviations from potential output, while classical cycle tracks absolute fluctuations in level of activity.

Four phases of a typical business cycle.

Recovery, expansion, slowdown (peak), contraction (recession).

What happens to inventories early in a recovery?

They decline as sales rise faster than production.

Which employment measure is a lagging indicator?

Average duration of unemployment.

Give an example of a coincident indicator.

Industrial production index, real personal income, or non-farm payrolls.

Example of an automatic stabiliser in fiscal policy.

Progressive income tax or unemployment benefits that change with the cycle without new legislation.

Name two leading indicators used in the U.S. Conference Board LEI.

Stock prices (S&P 500) and building permits for new housing.

What is nowcasting?

Real-time estimation of current macro variables (e.g., GDP) using high-frequency data.

Fiscal multiplier concept.

Change in equilibrium output divided by autonomous change in government spending or taxation.

Balanced-budget multiplier value.

Approximately 1 (an equal rise in G and T still raises output).

Ricardian equivalence proposition.

Households save tax cuts financed by debt, anticipating future taxes, so deficits have no effect on demand.

Define structural (cyclically adjusted) budget deficit.

The deficit that would exist if the economy were at full employment; removes cyclical effects.

Crowding-out effect in fiscal policy.

Government borrowing raises interest rates, reducing private investment.

What is meant by recognition, action and impact lags?

Delays in identifying economic changes, enacting policy, and seeing its full effects.

Primary goal shared by monetary and fiscal policy?

To create a stable environment of positive growth with low, stable inflation.

Key advantage of indirect taxes for policy makers.

They can be implemented quickly and influence spending behaviour almost immediately.

Marginal propensity to consume (MPC) definition.

The fraction of an additional dollar of disposable income that is spent on consumption.

How do automatic stabilisers affect the multiplier?

They lower it, reducing fluctuations in output.

Why may high debt-to-GDP ratios be problematic?

Risk of higher future taxes, potential loss of market confidence, crowding-out, or inflationary finance.

Why might high debt-to-GDP ratios NOT be a problem?

Debt is often domestic, may finance growth-enhancing investment, and inflation erodes real burden.

Tool of contractionary fiscal policy?

Reducing discretionary government spending or raising taxes to lower aggregate demand.

Current government spending vs. capital expenditure.

Current spending is recurring (e.g., wages, supplies); capital expenditure is long-term investment (e.g., infrastructure).

Direct tax example.

Personal income tax or corporate profits tax.

Indirect tax example.

Value-added tax (VAT) or excise duties on fuel.

What is the output gap?

Difference between actual and potential (trend) output.

Define minimum AVC shutdown condition.

Operate only if price ≥ minimum average variable cost; otherwise shut down.

Purpose of the OECD Composite Leading Indicator (CLI).

Provides early signals of turning points in economic activity for member countries.

Effect on MR when monopolist lowers price to sell extra unit.

MR is below price because all units are now sold at the lower price.

Why does a monopolist produce where MR = MC but charge P > MC?

Price is taken from the demand curve at the profit-maximising quantity, giving a markup over cost.

Describe economies of scope (not scale).

Cost savings from producing multiple products together rather than separately.

Key characteristic of public goods justifying government provision.

Non-rival and non-excludable nature makes private provision inefficient.

Credit cycle definition.

Fluctuations in availability and pricing of credit that often run longer and deeper than business cycles.

Leading sector in credit cycle analysis.

Housing and real estate, given reliance on credit.

What does an inverted yield curve often signal?

Expectations of economic slowdown or recession.

Impact of capacity utilisation on capital spending.

High utilisation encourages new capital investment; low utilisation discourages it.

Two components of government revenue besides taxes.

Fees/charges and capital transfers (e.g., sale of assets).

Why are policy multipliers uncertain?

Because MPC, tax rates, and leakages (imports, savings) vary over time and across economies.

Fiscal stance indicated by rising structural deficit?

Expansionary fiscal policy.

Term for spending cuts and tax hikes enacted simultaneously to reduce deficit.

Austerity measures.

Long-run effect of persistent crowding-out.

Lower capital stock and slower potential growth.

Example of a non-price competition strategy in monopolistic competition.

Advertising or product differentiation through branding.

Why might a firm operate at a loss in the short run?

If price covers AVC, continuing production loses less than shutting down and paying fixed costs.

Relationship between elasticity and MR sign for monopolist.

MR positive when demand elastic (>1), zero at unit elasticity, negative when demand inelastic (<1).

Variable influencing breadth of composite indicator movement.

Diffusion index measures proportion of components moving consistently.

What are policy lags?

Delays between economic shock, recognition, policy action, and economic impact.

Effect of progressive taxes on automatic stabilisation.

They cause tax revenues to fall faster in downturns and rise faster in booms, smoothing demand.

Fiscal tool used to redistribute wealth.

Inheritance (estate) tax.

Define perfect price discrimination.

Monopolist charges each consumer their maximum willingness to pay; MR equals price and no consumer surplus remains.

Consequence of durable price wars in oligopoly.

Potential exit of weaker competitors and lower long-term industry profits.

Mechanism behind kinked demand curve gap in MR.

Different elasticities for price increases vs. decreases cause discontinuity in marginal revenue.

Key macro goal of balanced-budget amendment.

To enforce fiscal discipline by preventing persistent deficits.

Role of the multiplier in evaluating stimulus packages.

Estimates total impact on GDP of initial government spending or tax changes.

Primary government objective when using contractionary fiscal policy during boom.

Prevent overheating and curb rising inflation.