Economics Long-Run Equilibrium Quiz

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Questions and Answers

What condition indicates that firms are earning zero profits in the long-run equilibrium?

Demand exceeds average cost

Marginal cost is greater than average revenue

Demand is tangent to the average cost curve (correct)

Average cost equals marginal cost

What does the equilibrium price in this scenario denote?

The market price at which firms can make positive profits

The minimum average cost of production

The price at which firms face no competition

The price at which average cost equals marginal cost (correct)

In the given long-run equilibrium scenario, what happens to firms making positive profits?

They are likely to exit the industry (correct)

They increase production until demand increases

They lower their prices to match costs

They continue at the same output level indefinitely

What role does the marginal cost play in determining the position of the demand curve in this scenario?

It reflects the average revenue firms earn Signup and view all the answers

What does the demand curve d1 indicate in comparison to d0?

d1 is more elastic and flatter than d0 Signup and view all the answers

In the long-run equilibrium without trade, what happens to monopoly profits?

Firms earn zero monopoly profits Signup and view all the answers

What occurs when trade opens between Home and Foreign?

The number of customers for each firm doubles Signup and view all the answers

What is the outcome for firms expecting to earn profits at point B when trade opens?

Firms find themselves making losses at point B’ Signup and view all the answers

How does the introduction of trade affect the number of firms in the market?

The number of firms doubles Signup and view all the answers

What is indicated by the price PA in long-run equilibrium without trade?

It equals average cost Signup and view all the answers

What is a characteristic of the short-run equilibrium with trade?

Firms charge a uniform price Signup and view all the answers

What is the primary reason for trade according to the new model of intra-industry trade?

Economies of scale that prevent complete production of goods by individual countries. Signup and view all the answers

In the context of intra-industry trade, which statement best describes the nature of goods involved?

Goods are highly differentiated and include various varieties of the same product. Signup and view all the answers

What is one of the main predictions of the model regarding larger countries and trade?

Larger countries tend to trade more, reflecting the gravity equation of trade. Signup and view all the answers

How does intra-industry trade benefit domestic consumers?

By increasing the variety of goods available while lowering production levels. Signup and view all the answers

Under what market condition does the new model of intra-industry trade operate?

Monopolistic competition characterized by several firms producing differentiated products. Signup and view all the answers

What does intra-industry trade allow countries to achieve in terms of productivity?

Higher productivity by producing fewer varieties at larger scales. Signup and view all the answers

What concept explains that countries trade different varieties of the same good?

Intra-industry trade. Signup and view all the answers

Why do economies of scale contribute to intra-industry trade?

They allow countries to specialize and produce larger quantities of fewer goods. Signup and view all the answers

What is a characteristic of firms in a monopolistic competition setting?

Each firm produces a variety of a differentiated good. Signup and view all the answers

How do firms in monopolistic competition behave, regarding price?

They behave as monopolists for their specific variety. Signup and view all the answers

What distinguishes monopolistic competition from perfect competition?

There are several firms, each offering a differentiated product. Signup and view all the answers

In monopolistic competition, how is the demand experienced by each firm affected?

Demand is downward-sloping for the specific variety produced by the firm. Signup and view all the answers

What condition is necessary for a market to be classified as operating under perfect competition?

There must be a large number of buyers with complete information. Signup and view all the answers

In the context of monopolistic competition, what is the significance of the assumption that firms produce different varieties?

It allows firms to secure a monopolistic position over their product variety. Signup and view all the answers

What happens to the demand faced by individual firms as the number of firms in monopolistic competition increases?

Each firm's demand decreases as they share the market demand. Signup and view all the answers

What is the relationship between marginal revenue and marginal cost in a monopolistic market?

Firms maximize profits when marginal revenue equals marginal cost. Signup and view all the answers

What happens to firms in the industry enjoying monopoly profits when prices drop to P2?

They will incur losses and some will go bankrupt. Signup and view all the answers

At what point does a firm achieve equilibrium in the short-run when trade is involved?

When MR equals MC. Signup and view all the answers

What is the consequence for firms that sell at a price below average cost (AC)?

They will face incurred losses and potential exit from the market. Signup and view all the answers

How does trade influence the pricing behavior of firms in an industry?

It forces some firms to lower their prices to remain competitive. Signup and view all the answers

What does the demand curve D/N indicate about the elasticity of demand in this context?

It is elastic. Signup and view all the answers

During the short-run equilibrium with trade, how are firms positioned in terms of profits?

Some firms make monopoly profits while others incur losses. Signup and view all the answers

What does the figure illustrate about firm behavior when reaching point Q2?

Firms incur losses and will consider exiting the industry. Signup and view all the answers

What could be a long-run effect of firms exiting the industry due to losses?

Reduction in total supply, potentially stabilizing prices. Signup and view all the answers

What happens to the number of firms in an industry when trade is introduced?

It increases. Signup and view all the answers

Which of the following statements is true regarding prices in long-run equilibrium with trade?

Prices are lower than without trade. Signup and view all the answers

In long-run equilibrium without trade, what is the relationship between the quantities produced Q3 and Q1?

Q3 is greater than Q1. Signup and view all the answers

What is the main impact of the exit of some firms in long-run equilibrium with trade?

It leads to an increase in the remaining firms' output. Signup and view all the answers

How does intra-industry trade affect the variety of products available to consumers?

It increases the variety of products. Signup and view all the answers

In the context of intra-industry trade, what is a characteristic of the remaining firms after some exit?

They operate with lower production costs. Signup and view all the answers

What is the formula that indicates the relationship between the number of firms in trade and no trade?

2NT > NA Signup and view all the answers

What occurs to the average cost (AC) of production in long-run equilibrium with trade compared to without trade?

AC decreases due to economies of scale. Signup and view all the answers

Study Notes

World Economics - Chapter 6: Intra-Industry Trade

Chapter 6, Intra-industry Trade: Economies of Scale and Imperfect Competition, analyzes trade in scenarios of monopolistic competition.
The chapter examines different equilibrium types, both short-run and long-run, in the presence (and absence) of trade, and includes empirical examples.
Core topics for analysis include the index of Intra-Industry Trade and the Gravity Equation of Trade.
Relevant references include Feenstra, Robert C., and Alan M. Taylor, International Trade, Economics (MacMillan, 2017, 4th Edition).

Chapter Structure and Content

The chapter begins with an introduction.
It will then delve into the economic theory behind trade models under monopolistic competition and increasing returns, providing specifics.
Finally, the chapter investigates the empirical implications of monopolistic competition and trade using empirical applications, such as trade indexes and the Gravity Equation of Trade.

Intra-Industry Trade

Intra-industry trade plays a significant role in international trade, exemplifying countries that export and import the same kinds of products within an industry (e.g., cars, wine, computers, golf clubs).
This phenomenon requires a different explanation than typical comparative advantage-based models, which often focus on inter-industry trade.

Key Assumptions for Trade Models

Assumption 1 (Differentiated goods): Each firm produces a variety of differentiated goods (product variety) which are imperfect substitutes for each other, unlike homogeneous goods. This creates downward-sloping firm demand curves.
Assumption 2 (Many Firms): The industry has many (at least two ≥ 2) firms.
Assumption 3 (Economies of Scale): Average costs decrease as quantity produced increases, fueled by fixed costs like initial investments for machinery or research.
Assumption 4 (Free Entry and Exit): Firms freely enter and leave the industry in response to profits, guaranteeing long-run zero-average profits across the industry.
Assumption 5 (Love for Variety): Consumers desire variety/mixed bundles of both domestic and foreign products.

Equilibrium analysis in a No-Trade Scenario

Firms behave as monopolists in a no-trade scenario, maximizing profits where marginal revenue equals marginal cost.
Short-run equilibrium, shown in Figure 6.4, reveals that profits will exist because price > average cost.
Long-run equilibrium, shown in Figure 6.5, establishes a new equilibrium as these profits attract further entry into the market, driving average profits down to zero when the demand curve (facing each firm) becomes tangent to marginal cost.

Equilibrium analysis with Trade

When countries trade, the initial demand facing each firm expands by twice its initial customer base.
The new short-run equilibrium (Figure 6.6) demonstrates that, despite the increase in the customer base, each firm's individual demand is now flatter due to increased competition. This dynamic often results in losses for the firms.
Ultimately, the long-run trade equilibrium (Figure 6.7) results in firms exiting the market until the new equilibrium number of firms (NT) is less than the non-trade equilibrium number (NA). The resulting lower number of firms and prices generate a more favorable environment for consumers due to the increased variety and lower prices.

The Gravity Equation of Trade

The model anticipates larger countries and those geographically closer (e.g., nearby states or countries) engaging in greater trade.
This prediction is supported by empirical evidence, measuring the impact of GDP and distance on trade flows to predict trade volumes.

Empirical Applications and Data

Datasets (tables and graphs) in the text show intra-industry trade indexes for a variety of countries and products over time.
Examples are discussed for trade between the US states and Canadian provinces, Spanish trade and other countries.
The data supports the existence of a strong relationship between a country's size, proximity to others, and the volume of their trade.

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Description

Test your understanding of long-run equilibrium in economics. This quiz covers essential concepts such as profit conditions, market dynamics, and the impact of trade on firms and prices. Dive into the nuances of equilibrium price and marginal cost relationships.