Economics Factor Markets and Government Role

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Questions and Answers

What happens to firms that make excess profits in the short run?

They expand their capacity. (correct)

They decrease their capacity.

They maintain the same level of output.

They close down immediately.

In long-run equilibrium, how do firms adjust their production?

By producing at any point below their long-run AC curve.

By producing at the minimum point of their long-run AC curve. (correct)

By producing at a level of output that leads to losses.

By producing at the maximum point of their long-run AC curve.

What ultimately happens during the long-term adjustment process if firms incur losses?

Costs decrease regardless of firm exits.

Firms exit the industry. (correct)

New firms enter the industry.

The price remains constant.

At long-run equilibrium, what type of profit do firms earn?

Normal profits. Signup and view all the answers

What effect does the entry of new firms into an industry have on market prices?

Prices decrease as supply increases. Signup and view all the answers

What happens to the average cost curves as firms expand in the long run?

They shift upward due to increased factor prices. Signup and view all the answers

What is the market condition when quantity demanded equals quantity supplied?

Equilibrium. Signup and view all the answers

What occurs at the point where the long-run average cost (LAC) curve is tangent to the demand curve?

Firms only cover their total costs including normal profit. Signup and view all the answers

What is a key distinction between factor markets and product markets?

Factor markets deal with inputs, while product markets sell outputs. Signup and view all the answers

Which factor primarily influences wage differentials among workers?

The level of education and skill possessed by workers. Signup and view all the answers

What determines the equilibrium in factor markets?

The interaction of labor and capital supply and demand. Signup and view all the answers

Which concept describes the negative consequences of market power?

Market failure due to inefficiencies. Signup and view all the answers

What is a moral hazard in the context of information asymmetry?

The risk that one party alters their behavior because they are shielded from risk. Signup and view all the answers

What is the tragedy of the commons primarily concerned with?

The misuse of shared natural resources. Signup and view all the answers

Which of the following factors does NOT affect land rent?

The color of the land. Signup and view all the answers

What is a main cause of market failure due to incomplete information?

Consumers making uninformed decisions. Signup and view all the answers

What is the closing-down point for a firm?

The point where the firm covers its variable costs Signup and view all the answers

What happens to the firm if the market price falls below Pw?

The firm closes down Signup and view all the answers

How is the supply curve of the firm derived?

By observing points of intersection of its MC curve and successive demand curves Signup and view all the answers

What effect does an increase in market price have on the demand curve for the firm?

It results in an upward shift of the demand curve Signup and view all the answers

What signifies that the supply curve of the firm is identical to its MC curve?

At prices above Pw Signup and view all the answers

What is the shape of the industry-supply curve?

A horizontal summation of individual firm supply curves Signup and view all the answers

What is the expected behavior of a firm when it cannot cover its variable costs?

Shut down production temporarily or permanently Signup and view all the answers

Under what conditions does the market supply increase?

When factor prices and technology remain constant Signup and view all the answers

What occurs at the point of tangency between the demand and average total cost curves?

Marginal revenue equals marginal cost. Signup and view all the answers

How does price behave in a monopolistically competitive market in the long run?

Price exceeds marginal cost. Signup and view all the answers

What drives economic profit to zero in a monopolistically competitive market?

Free entry and exit. Signup and view all the answers

What characterizes firms in monopolistic competition compared to firms in perfect competition?

They have excess capacity. Signup and view all the answers

Which statement differentiates monopoly from monopolistic competition in the long run?

Monopoly firms can earn positive economic profit. Signup and view all the answers

In a monopolistically competitive market, what is the relationship between average total cost and price in the long run?

Price equals average total cost. Signup and view all the answers

What feature of monopolistic competition leads to the production of output smaller than the efficient scale?

Downward-sloping demand curves. Signup and view all the answers

What describes the long-run equilibrium condition for a firm in monopolistic competition?

Marginal revenue equals marginal cost and economic profit is zero. Signup and view all the answers

What does the kinked-demand curve primarily explain in an oligopoly?

The tendency of prices to remain fixed despite changes in costs. Signup and view all the answers

Which statement correctly describes the kink in the kinked-demand curve?

It arises from the uncertainty of oligopolists and their expectations. Signup and view all the answers

Which of the following is NOT a type of collusion mentioned?

Price wars Signup and view all the answers

What role do trade associations play in collusion?

They disseminate information that helps firms coordinate indirectly. Signup and view all the answers

What does Sweezy's theory fail to define regarding the kinked-demand curve?

The specific price level at which the kink occurs. Signup and view all the answers

Why are open collusive actions often illegal?

They tend to limit competition and harm consumers. Signup and view all the answers

What distinguishes price leadership as a form of collusion?

It relies on one firm setting prices that others follow. Signup and view all the answers

What is the primary characteristic of collusion in oligopolistic markets?

It often involves secret agreements among firms. Signup and view all the answers

Study Notes

Factor Markets

Factor markets, like product markets, involve the buying and selling of goods and services but focus on factors of production, including land, labor, and capital.
The supply and demand of factors are driven by various determinants; for instance, labor demand is influenced by factors like technology and product prices, whereas labor supply depends on population, education, and wages.
The marginal productivity theory of wages suggests that wages are determined by the contribution of an additional unit of labor, which is affected by factors like worker skills, working conditions, and labor union presence.
Economic rent is a surplus payment to a factor above its opportunity cost, often seen in land, and is influenced by factors like location and land quality.

Information, Market Failure & the Role of Government

Market failures occur when free markets fail to allocate resources efficiently; this can be due to factors such as imperfect information, externalities (either positive or negative), or the presence of market power.
Common property resources, like fish stocks or forests, are vulnerable to overuse and depletion because of the lack of clear property rights, a phenomenon known as the tragedy of the commons.
Asymmetric information, where one party possesses more information than the other, can lead to adverse selection (where buyers or sellers with less information are disadvantaged) and moral hazard (where one party takes advantage of their superior information).

Short-Run Equilibrium of a Firm

The 'closing-down point' for a firm occurs when the price just covers variable costs, and below this point, the firm is better off shutting down.
The supply curve of an individual firm is derived from the intersection of its marginal cost (MC) curve with various demand curves.
The industry supply curve is the horizontal summation of the supply curves of individual firms, assuming identical technology and many firms.
In the short run, industry equilibrium occurs when quantity demanded equals quantity supplied, but this equilibrium might be affected by excess profits or losses made by individual firms.

Long-Run Equilibrium of a Firm

Firms in long-run equilibrium produce where their long-run average cost (LAC) curve is tangent to the demand curve, indicating normal profits.
Excess profits in the long run attract new firms, causing price to fall and cost curves to rise, ultimately restoring equilibrium.
Losses in the long run lead to firm exits, causing price to rise and costs to fall, leading to a long-run equilibrium where surviving firms earn normal profits.

Monopolistic Competition

In monopolistic competition, the long-run equilibrium is characterized by firms producing at a level below the minimum point of their average total cost curve, indicating excess capacity.
In the long run, firms under monopolistic competition earn zero economic profits, but price exceeds marginal cost due to product differentiation and downward-sloping demand curves.

Oligopoly

The kinked-demand curve theory suggests that prices in oligopolies tend to be rigid due to the uncertainty of competitors reacting to price changes.
Collusion, particularly in the form of cartels or price leadership, is a strategy used by oligopolists to reduce uncertainty and maximize profits, but often faces legal constraints.
Trade associations and other business organizations can facilitate tacit collusion by sharing information about prices and production plans.

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Description

Explore the dynamics of factor markets, including the buying and selling of labor, land, and capital. Understand concepts like marginal productivity theory and economic rent, as well as market failures and the government's role in correcting inefficiencies. This quiz will test your knowledge on these essential economic principles.