Oligopoly Models

Questions and Answers

What is a characteristic of oligopolistic firms in terms of product differentiation?

They may produce either homogenous or differentiated products. (correct)

They only produce differentiated products.

They only produce homogenous products.

They do not produce any products.

Which of the following models is used to understand the competitive forces that determine the level of competition and profitability in an industry?

Prisoner's Dilemma

Game Theory Strategies

Five Forces model (correct)

Cournot Model

What is a scenario in which two firms simultaneously make decisions that result in a worse outcome for both firms than if they had made different decisions?

Duopoly

Prisoner's Dilemma (correct)

Price Leadership

Cournot Model

Which of the following is a type of market structure characterized by two dominant firms?

Duopoly Signup and view all the answers

Which of the following models is used to analyze the strategic interaction between firms in an oligopolistic market?

Game Theory Strategies Signup and view all the answers

What is the characteristic of a dominant firm in a price-leadership model?

It sets prices and all the smaller firms in the industry follow its pricing policy. Signup and view all the answers

What is the key feature of a game theory strategy?

It is a strategy that is best no matter what the opposition does. Signup and view all the answers

What is the result of moving from a monopolist to Cournot duopolists in the Cournot model?

Total industry output increases, but not as high as the competitive output. Signup and view all the answers

What type of game is characterized by a payoff matrix where both players have a dominant strategy?

Advertising Game Signup and view all the answers

What is the term for a market structure with two firms?

Duopoly Signup and view all the answers

In a single play of the airline game, what is the dominant strategy for British Airways if Lufthansa Airlines prices at $600?

Price at $400 Signup and view all the answers

What is the primary goal of a tit-for-tat strategy in a repeated game?

To respond in kind to an opponent's play Signup and view all the answers

What is the primary outcome of a multiple-player game that results in a prisoner's dilemma?

Dominant strategies result in a suboptimal outcome Signup and view all the answers

What is the necessary condition for oligopoly to exist in a market?

Firms must be large enough to have some control over price Signup and view all the answers

What is the typical outcome of concentration in a market, according to the oligopoly model?

Pricing above marginal cost and output below the efficient level Signup and view all the answers

What is the primary purpose of horizontal differentiation in a monopolistically competitive market?

To cater to the diverse tastes of consumers and make products better for some people and worse for others Signup and view all the answers

According to researchers in behavioral economics, what is the effect of too much choice on purchases?

It reduces purchases Signup and view all the answers

What is the purpose of a commitment device in the context of consumer behavior?

To help individuals control their behavior in a future period Signup and view all the answers

What is the primary characteristic of vertical differentiation?

It makes a product better than rival products from everyone's perspective Signup and view all the answers

What is one of the roles that advertising plays in product differentiation?

It informs people about the real differences that exist among products Signup and view all the answers

What occurs when existing firms in a monopolistically competitive industry experience a decline in demand due to the entry of new firms?

Their demand curves shift to the left and marginal revenue shifts with them. Signup and view all the answers

Which of the following is an example of a commitment device in the context of monopolistic competition?

A firm's decision to pre-commit to a certain level of production to deter entry by new firms. Signup and view all the answers

What is the main difference between horizontal and vertical product differentiation?

Horizontal differentiation refers to differences between products that are perceived as similar, while vertical differentiation refers to differences between products that are perceived as different. Signup and view all the answers

Which of the following is a potential benefit of product differentiation in monopolistic competition?

It leads to the introduction of new products and improvements in old products, which can increase economic welfare. Signup and view all the answers

What is the relationship between the equilibrium of a monopolistically competitive firm and its average total cost curve?

The equilibrium is to the left of the low point of the average total cost curve, which means the firm does not realize all the economies of scale available. Signup and view all the answers

What is a key difference between the demand curve of a monopolistic competitor and that of a perfectly competitive firm?

The demand curve of a monopolistic competitor is less elastic. Signup and view all the answers

In the short run, a monopolistically competitive firm will produce up to the point where:

MR = MC Signup and view all the answers

What is a characteristic of monopolistic competition in the long run?

Entry and exit are easy. Signup and view all the answers

What is the result of the MR curve of a monopolistic competitor?

It lies below the demand curve. Signup and view all the answers

What is the goal of a monopolistically competitive firm in the short run?

To maximize profit. Signup and view all the answers

What is the primary purpose of households supplying funds to the money market?

To earn income in the form of dividends on stocks and interest on bonds Signup and view all the answers

Who borrows from the money market to finance new facilities?

Firms Signup and view all the answers

What is the term for the financial instruments that give the holder a share in the firm's ownership?

Shares of stock Signup and view all the answers

What is the term for the portion of a firm's profits that the firm pays out each period to its shareholders?

Dividends Signup and view all the answers

What is the government's policy concerning taxes and spending?

Fiscal policy Signup and view all the answers

What is the term for the tools used by the Federal Reserve to control short-term interest rates?

Monetary policy Signup and view all the answers

Who coordinates borrowing and lending in the money market?

Financial institutions Signup and view all the answers

What is the term for the promissory notes issued by the federal government when it borrows money?

Treasury bonds Signup and view all the answers

Who borrows from and lends to the money market?

The rest of the world Signup and view all the answers

What is the primary purpose of the money market?

To facilitate borrowing and lending between households, firms, the government, and the rest of the world Signup and view all the answers

What is the difference between national income and personal income?

National income is the total income earned by households and firms, while personal income is the total income earned by households after taxes. Signup and view all the answers

What is the percentage of disposable personal income that is saved, according to Table 21.5?

3.4% Signup and view all the answers

What is the amount of disposable personal income, according to Table 21.5?

14,379.0 Signup and view all the answers

What is the amount of personal income taxes, according to Table 21.5?

2,048.3 Signup and view all the answers

What is the amount of personal saving, according to Table 21.5?

485.9 Signup and view all the answers

What is the difference between personal income and disposable personal income?

Personal income taxes Signup and view all the answers

What is the main difference between Gross National Product (GNP) and Net National Product (NNP)?

GNP is the total value of goods and services produced by a nation, while NNP is the total value of goods and services produced by a nation minus what is required to maintain the value of its capital stock. Signup and view all the answers

What is the purpose of subtracting depreciation from Gross National Product (GNP) to obtain Net National Product (NNP)?

To maintain the value of a nation's capital stock. Signup and view all the answers

What is the term for the error that occurs in data measurement when calculating national income accounts?

Statistical discrepancy. Signup and view all the answers

What is the relationship between national income and household income?

National income is the total income of a nation, while household income is the total income of households. Signup and view all the answers

What is the formula to calculate Gross Domestic Product (GDP) in terms of Gross National Product (GNP)?

GDP = GNP + Receipts of factor income from the rest of the world - Payments of factor income to the rest of the world. Signup and view all the answers

What is the purpose of the statistical discrepancy in the calculation of national income accounts?

To account for errors in data measurement. Signup and view all the answers

What is the percentage of corporate profits in the national income of 2017?

13.0% Signup and view all the answers

What is the total amount of national income in 2017?

16,607.7 billion dollars Signup and view all the answers

What is the percentage of compensation of employees in the national income of 2017?

62.1% Signup and view all the answers

What is the amount of rental income in the national income of 2017?

743.9 billion dollars Signup and view all the answers

What is the amount of net interest in the national income of 2017?

586.4 billion dollars Signup and view all the answers

What is the percentage of indirect taxes minus subsidies in the national income of 2017?

7.6% Signup and view all the answers

What is the amount of surplus of government enterprises in the national income of 2017?

-11.0 billion dollars Signup and view all the answers

What is the percentage of net business transfer payments in the national income of 2017?

1.0% Signup and view all the answers

What is the effect of unanticipated inflation on debtors and creditors?

Debtors gain and creditors lose. Signup and view all the answers

What is the result of administrative costs associated with anticipated inflation?

Higher opportunity costs of holding cash. Signup and view all the answers

What happens to borrowers and lenders when prices are falling unanticipatedly?

Borrowers gain and lenders lose. Signup and view all the answers

What is the relationship between interest rates and anticipated inflation?

Interest rates increase with anticipated inflation. Signup and view all the answers

What is the difference between output growth, per-capita output growth, and productivity growth?

Output growth refers to the growth rate of the entire economy, per-capita output growth refers to the growth rate of output per person, and productivity growth refers to the growth rate of output per worker. Signup and view all the answers

What is the primary reason why the costs of unemployment are not evenly distributed across the population?

The poor and fully unemployed tend to be the most affected Signup and view all the answers

What is the difference between the Consumer Price Index (CPI) and Producer Price Indexes (PPIs)?

CPI measures prices paid by consumers, while PPIs measure prices received by producers Signup and view all the answers

What is the primary consequence of inflation?

Most prices, including input prices like wages, tend to rise together Signup and view all the answers

What is the purpose of the Consumer Price Index (CPI) market basket?

To show how a typical consumer divides their money among various goods and services Signup and view all the answers

What is a characteristic of cyclical unemployment?

It is always above frictional plus structural unemployment Signup and view all the answers

What is the name of the measure that tracks the average change in prices of a fixed basket of goods and services purchased by households?

Consumer Price Index (CPI) Signup and view all the answers

What is the term for a person who is not looking for work because they do not want a job or have given up looking?

Not in the labor force Signup and view all the answers

What is the formula for calculating the labor force?

Labor force = Employed + Unemployed Signup and view all the answers

What is the term for the ratio of the number of people unemployed to the total number of people in the labor force?

Unemployment rate Signup and view all the answers

Which of the following is NOT a category of people when measuring unemployment?

Underemployed Signup and view all the answers

What is the marginal propensity to consume (MPC) equal to?

The fraction of a change in income that is consumed Signup and view all the answers

What is the relationship between the marginal propensity to consume (MPC) and the marginal propensity to save (MPS)?

MPC + MPS = 1 Signup and view all the answers

What is the change in consumption for every $100 increase in income, according to the consumption function C = 100 + 0.75Y?

$75 Signup and view all the answers

What is the value of aggregate saving when aggregate income is $800, according to the saving function derived from the consumption function in Figure 23.3?

$100 Signup and view all the answers

What is the equation for the aggregate saving (S)?

S = Y - C Signup and view all the answers

What is the meaning of the triple equal sign (º) in the equation S º Y - C?

It indicates an identity, or something that is always true by definition Signup and view all the answers

At what level of income does consumption equal income, according to Figure 23.3?

$400 Signup and view all the answers

What does the upward slope of the aggregate consumption function indicate?

Higher levels of income lead to higher levels of consumption Signup and view all the answers

What is the relationship between income and consumption in the simple consumption function C = 100 + 0.75Y?

Consumption increases as income increases Signup and view all the answers

What is the value of consumption when income is zero, according to the consumption function C = 100 + 0.75Y?

$100 Signup and view all the answers

What is the term used to describe the combined total of goods and services produced and income received by all factors of production in a given period?

Aggregate Output (Income) Signup and view all the answers

What is the relationship between consumption and income, as described by Keynes?

Consumption is directly related to income Signup and view all the answers

What is the term used to describe the relationship between consumption and income for an individual household?

Consumption Function Signup and view all the answers

When thinking about aggregate output, what is important to keep in mind?

The quantities of goods and services produced Signup and view all the answers

What is the term used to describe the total quantity of goods and services produced in an economy in a given period?

Aggregate Output Signup and view all the answers

What is the primary argument against the claim that cheap foreign labor makes competition unfair?

Wages in a competitive economy reflect productivity, and trade flows according to comparative advantage. Signup and view all the answers

What is the deadweight loss or excess burden resulting from the tariff?

The triangle labeled ABC in panel (b) Signup and view all the answers

What is the primary argument for protecting industries in areas where a country has a comparative disadvantage?

To prevent trading relationships that might lead to political dependence. Signup and view all the answers

What is the primary purpose of imposing penalties on high-polluting products, according to some environmental groups?

To make the prices of goods imported reflect the harm that those products cause. Signup and view all the answers

What is the primary argument for protecting national security?

Even if we acknowledge another country's comparative advantage, we may want to protect our own resources. Signup and view all the answers

What is the primary goal of aiding victims of free trade constructively?

To forgo the gains from trade without sacrificing the benefits of free trade. Signup and view all the answers

What is the main advantage of comparative advantage over absolute advantage in international trade?

It allows countries to specialize in the production of goods for which they have a relative advantage. Signup and view all the answers

What is the primary effect of a tariff on international trade?

It increases the price of imported goods, leading to a decrease in demand. Signup and view all the answers

What is the primary goal of a country's trade policy?

To promote free trade and increase economic efficiency. Signup and view all the answers

What is the effect of a trade surplus on a country's exchange rate?

It increases the demand for the domestic currency, causing the exchange rate to appreciate. Signup and view all the answers

What is the primary difference between the Corn Laws and the theory of comparative advantage?

The Corn Laws restricted trade, while the theory of comparative advantage promoted free trade. Signup and view all the answers

What is the primary effect of trade barriers on international trade?

They decrease the efficiency of international trade by reducing the volume of trade. Signup and view all the answers

What is the primary argument in favor of providing protection to infant industries?

To allow them to develop a comparative advantage Signup and view all the answers

Which of the following best describes the trend in trade openness across the world from 1980 to 2005?

There has been a rapid reduction in tariffs, especially in emerging and developing markets Signup and view all the answers

According to the theory of comparative advantage, what is the outcome of free international trade?

It raises real incomes and improves the standard of living Signup and view all the answers

What is the primary reason why economists favor free trade?

It raises real incomes and improves the standard of living Signup and view all the answers

What is the effect of tariffs on trade openness?

They decrease trade openness by increasing trade barriers Signup and view all the answers

What is the relationship between trade barriers and real incomes?

Trade barriers decrease real incomes by reducing trade and specialization Signup and view all the answers

What is the primary goal of international trade policies?

To promote free trade and increase trade openness Signup and view all the answers

What is the effect of reducing trade barriers on the standard of living?

It increases the standard of living by increasing trade and specialization Signup and view all the answers

What happens to the price of U.S.-made goods and services to British buyers when the price of pounds rises?

It becomes less expensive Signup and view all the answers

What is the result of an excess demand for pounds in the foreign exchange market?

The pound appreciates Signup and view all the answers

According to the purchasing-power-parity theory, what happens to the currencies of countries with high inflation rates?

They depreciate Signup and view all the answers

What is the equilibrium exchange rate in the foreign exchange market?

The point at which the quantity of pounds supplied equals the quantity demanded Signup and view all the answers

What happens to the exchange rate when there is an excess supply of pounds in the foreign exchange market?

The pound depreciates Signup and view all the answers

What is the law of one price, according to the purchasing-power-parity theory?

The price of the same good is the same in different countries if transportation costs are low Signup and view all the answers

What happens to the supply of pounds when U.S. interest rates rise relative to British interest rates?

The supply of pounds shifts to the right Signup and view all the answers

What is the effect of a higher price level in the United States on the demand for imports from Britain?

The demand for imports increases Signup and view all the answers

What is the result of an appreciation of the pound vis-à-vis the dollar?

The price of British goods decreases for U.S. citizens Signup and view all the answers

What is the effect of exchange rate changes on the economy?

Affects the level of imports and exports, which in turn affects the level of real GDP and the price level Signup and view all the answers

What is the likely outcome when the British see U.S. goods getting more expensive?

The British reduce their demand for U.S. exports Signup and view all the answers

What is the result of an increase in the price of pounds?

The dollar appreciates vis-à-vis the pound Signup and view all the answers

What is the likely effect of a high inflation rate abroad on U.S. import prices?

They will increase Signup and view all the answers

What is the term for the process by which a domestic price increase in one country can 'feed back' on itself through export and import prices?

Price Feedback Effect Signup and view all the answers

What type of exchange rate is determined by the unregulated forces of supply and demand?

Floating Exchange Rate Signup and view all the answers

What happens to the quantity of pounds demanded when the price of pounds falls?

It increases Signup and view all the answers

What is the likely effect of a depreciation of the domestic currency on the trade balance?

It will improve Signup and view all the answers

What is the term for the temporary deterioration of the trade balance following a depreciation of the domestic currency?

J-Curve Effect Signup and view all the answers

What is the primary factor that determines the price level in an open economy?

Export Prices Signup and view all the answers

What is the likely effect of an appreciation of the domestic currency on import prices?

They will decrease Signup and view all the answers

Study Notes

Oligopoly Models

A cartel is a group of firms that makes joint price and output decisions to maximize joint profits.
Tacit collusion occurs when price- and quantity-fixing agreements among producers are implicit.
The Price-Leadership Model is a form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.
The Cournot Model is a duopoly model, where two firms make output decisions to maximize their profits.

Game Theory

Game theory analyzes the choices made by rival firms, people, and governments when they are trying to maximize their own well-being while anticipating and reacting to the actions of others in their environment.
A dominant strategy is a strategy that is best no matter what the opposition does.
The Nash equilibrium is a result where each player is doing the best they can given what the other is doing.

Oligopoly

Oligopoly is a form of industry structure characterized by a few dominant firms.
Products may be homogenous or differentiated.
Oligopolists compete with one another not only in price but also in developing new products, marketing, and advertising.
The Five Forces model helps us understand the five competitive forces that determine the level of competition and profitability in an industry.

Repeated Games

A tit-for-tat strategy is a repeated game strategy in which a player responds in kind to an opponent's play.

Prisoner's Dilemma

A multiple-player game can result in a classic prisoners' dilemma, where collusion if it could be enforced would result in an optimal outcome but where dominant strategies result in a suboptimal outcome.
To break this dilemma, we pass laws that allow government to become a player.

Oligopoly and Economic Performance

Concentration in a market leads to pricing above marginal cost and output below the efficient level, except with the contestable-markets model.
The only necessary condition of oligopoly is that firms are large enough to have some control over price.

Product Variety and Firm Differentiation

In well-working markets, product variety reflects consumer taste heterogeneity, gains from coordination, and cost economies due to standardization.
In monopolistically competitive industries, many firms produce different products, driven by consumer taste differences, lack of need for coordination, and modest scale economies.

Types of Product Differentiation

Horizontal differentiation: products differ in ways that make them better for some people and worse for others.
Vertical differentiation: products have differences that make them better than rivals from everyone's perspective.

Behavioral Economics and Choice

Researchers in behavioral economics find that people highly value some choice, but too much choice can reduce purchases.
Commitment devices: individuals take actions to control their behavior in the future, such as buying gym memberships to incentivize workouts.

Advertising and Product Differentiation

Advertising informs people about real product differences and creates or contributes to product differentiation by creating brand images.
Product differentiation reduces the elasticity of demand facing a firm.

Monopolistic Competition in the Short Run

A profit-maximizing monopolistically competitive firm behaves like a monopolist in the short run, with marginal revenue not equal to price.
The firm chooses the output/price combination that maximizes profit.

Monopolistic Competition in the Long Run

Entry and exit are easy in the long run, with profits providing an incentive for new firms to enter and firms that suffer losses can go out of business.
As new firms enter, demand curves of existing firms shift to the left, pushing marginal revenue down, until profits are eliminated.

Economic Efficiency and Resource Allocation

Monopolistic competition is efficient, but has two problems:
- Firms hold down production and charge a price above marginal cost to maintain market power.
- The equilibrium is to the left of the low point on the average total cost curve, preventing realization of all economies of scale.
Product differentiation can lead to new products, improvements, and greater variety, counteracting these problems.

Introduction to Macroeconomics

Macroeconomics deals with the economy as a whole, focusing on the determinants of total national income, aggregates such as aggregate consumption and investment, and the overall level of prices.
Macroeconomics examines the behavior of all households and firms together, known as aggregate behavior.
Sticky prices are prices that do not always adjust rapidly to maintain equality between quantity supplied and quantity demanded.

Macroeconomic Concerns

Three major concerns of macroeconomics are:
Output growth
Unemployment
Inflation and deflation

Output Growth

The business cycle refers to the cycle of short-term ups and downs in the economy.
Aggregate output is the total quantity of goods and services produced in an economy in a given period.
An expansion or boom is the period in the business cycle from a trough up to a peak during which output and employment grow.
A contraction, recession, or slump is the period in the business cycle from a peak down to a trough during which output and employment fall.
A depression is a prolonged and deep recession.

Figure 20.1: A Typical Business Cycle

The economy expands as it moves from the trough to the peak.
The economy is in recession when it moves from a peak down to a trough.

Figure 20.2: U.S. Aggregate Output (Real GDP), 1900–2017

The periods of the Great Depression and World Wars I and II show the largest fluctuations in aggregate output.

Unemployment

The unemployment rate is the percentage of the labor force that is unemployed.
The existence of unemployment implies that the aggregate labor market is not in equilibrium.

Inflation and Deflation

Inflation is an increase in the overall price level.
Hyperinflation is a period of very rapid increases in the overall price level.
Deflation is a decrease in the overall price level.

The Components of the Macroeconomy

The macroeconomy consists of four broad groups:
1. Households
2. Firms
3. The government
4. The rest of the world
Households and firms make up the private sector, the government is the public sector, and the rest of the world is the foreign sector.

The Circular Flow Diagram

The circular flow diagram shows the flows in and out of the sectors in the economy.
Transfer payments are cash payments made by the government to people who do not supply goods, services, or labor in exchange for these payments.

Figure 20.3: The Circular Flow of Payments

Households receive income from firms and the government, purchase goods and services from firms, and pay taxes to the government.
Firms receive payments from households and the government for goods and services, pay wages, dividends, interest, and rents to households and taxes to the government.
The government receives taxes from firms and households, pays firms and households for goods and services, and pays interest and transfers to households.

The Three Market Arenas

The three market arenas are:
1. The goods-and-services market
2. The labor market
3. The money (financial) market
Households, firms, the government, and the rest of the world interact in these market arenas.

The Goods-and-Services Market

Households and the government purchase goods and services from firms in the goods-and-services market.
Firms purchase goods and services from each other and also supply to the goods-and-services market.
The rest of the world buys from and sells to the goods-and-services market.

The Labor Market

Households supply labor, and firms and the government demand labor in the labor market.
Labor is also supplied to and demanded from the rest of the world.

The Money Market

Households supply funds to the money market in the expectation of earning income.
Households also demand (borrow) funds from this market to finance various purchases.
Firms borrow to build new facilities in the hope of earning more in the future.
The government borrows by issuing bonds, and the rest of the world borrows from and lends to the money market.

The Role of the Government in the Macroeconomy

Fiscal policy refers to government policies concerning taxes and spending.
Monetary policy refers to the tools used by the Federal Reserve to control short-term interest rates.

National Income Accounts

Net national product (NNP) is the total product of a nation minus the value required to maintain its capital stock, which is its gross national product (GNP) minus depreciation.
Statistical discrepancy refers to data measurement errors.

GDP, GNP, NNP, and National Income

In 2017, the GDP of the US was $19,390.6 billion.
The GNP was 19,607.4billion,whichistheGDPplusreceiptsoffactorincomefromtherestoftheworld(19,607.4 billion, which is the GDP plus receipts of factor income from the rest of the world (19,607.4billion,whichistheGDPplusreceiptsoffactorincomefromtherestoftheworld(934.7 billion) minus payments of factor income to the rest of the world ($717.9 billion).
The NNP was 16,572.7billion,whichistheGNPminusdepreciation(16,572.7 billion, which is the GNP minus depreciation (16,572.7billion,whichistheGNPminusdepreciation(3,034.7 billion).
National income was 16,607.7billion,whichistheNNPplusthestatisticaldiscrepancy(−16,607.7 billion, which is the NNP plus the statistical discrepancy ( -16,607.7billion,whichistheNNPplusthestatisticaldiscrepancy(−35.0 billion).

Personal Income and Saving

Disposable personal income, or after-tax income, is personal income minus personal income taxes.
Personal saving is the amount of disposable income left after total personal spending in a given period.
The personal saving rate is the percentage of disposable personal income that is saved.
In 2017, the personal income was 16,427.3billion,disposablepersonalincomewas16,427.3 billion, disposable personal income was 16,427.3billion,disposablepersonalincomewas14,379.0 billion, and personal saving was $485.9 billion.
The personal saving rate in 2017 was 3.4%.

Components of National Income

In 2017, the components of national income were:
- Compensation of employees: 62.1% of national income
- Proprietor's income: 8.3% of national income
- Rental income: 4.5% of national income
- Corporate profits: 13.0% of national income
- Net interest: 3.5% of national income
- Indirect taxes minus subsidies: 7.6% of national income
- Net business transfer payments: 1.0% of national income
- Surplus of government enterprises: -0.1% of national income

Inflation and Purchasing Power

Inflation by itself does not necessarily reduce one's purchasing power.

The Costs of Inflation

Inflation may change the distribution of income, with anticipated inflation having small effects and unanticipated inflation having large effects.
Actual inflation that is higher than anticipated benefits debtors, while inflation that is lower than anticipated benefits creditors.
Administrative costs and inefficiencies may occur even with anticipated inflation.
Interest rates tend to rise with anticipated inflation, and high interest rates increase the opportunity costs of holding cash outside banks.

Deflation

If falling prices are unanticipated, borrowers gain at the expense of lenders, and those on fixed pensions gain at the expense of governments and firms paying those pensions.

Long-Run Growth

Output growth refers to the growth rate of the entire economy's output.
Per-capita output growth refers to the growth rate of output per person in the economy.
Productivity growth refers to the growth rate of output per worker.
Cyclical unemployment is above frictional plus structural unemployment.

The Costs of Unemployment

The costs of unemployment are not evenly distributed across the population and are difficult to quantify.
Social consequences of unemployment can be severe, such as those experienced during the Depression of the 1930s.

Inflation and Deflation

The consumer price index (CPI) is a price index computed each month by the Bureau of Labor Statistics using a bundle that represents the typical urban consumer's purchases.
Producer price indexes (PPIs) measure prices that producers receive for products at all stages in the production process.

Measuring Unemployment

Employed individuals are those who work for pay, either for someone else or in their own business, or work without pay for 15 or more hours per week in a family enterprise.
Unemployed individuals are those who are not working, are available for work, and have made specific efforts to find work during the previous 4 weeks.
Not in the labor force refers to individuals who are not looking for work because they do not want a job or have given up looking.
Labor force is the number of people employed plus the number of unemployed.
Unemployment rate is the ratio of the number of people unemployed to the total number of people in the labor force.

The Keynesian Theory of Consumption

The aggregate consumption function shows the level of aggregate consumption at each level of aggregate income.
The upward slope of the aggregate consumption function indicates that higher levels of income lead to higher levels of consumption spending.

Equation for Consumption Curve

The equation for a straight-line consumption curve is C = a + bY.
The marginal propensity to consume (MPC) is the fraction of a change in income that is consumed, or spent.

Aggregate Saving (S)

Aggregate saving (S) is the part of aggregate income that is not consumed.
The equation for aggregate saving is S = Y - C, which is an identity.

Marginal Propensity to Save (MPS)

The marginal propensity to save (MPS) is the fraction of a change in income that is saved.
MPC + MPS = 1.

Example of Consumption Function

The equation C = 100 + 0.75Y represents a simple consumption function.
In this function, consumption is 100 at an income of zero, and for every 100 increase in income, consumption rises by 75.

Deriving the Saving Function

The saving function can be derived from the consumption function using the equation S = Y - C.
A 45° line can be used to compare consumption and income graphically.

Aggregate Output and Equilibrium Output

Aggregate output is the total quantity of goods and services produced in an economy in a given period.
Aggregate income is the total income received by all factors of production in a given period.
In any given period, there is an exact equality between aggregate output (production) and aggregate income.
The term aggregate output (income) (Y) is used to remind us of this equality.

Tariff and Deadweight Loss

The government collects revenue equal to the gray shaded area in panel (b)
The loss of efficiency has two components: consumers paying higher prices and marginal producers being drawn into textiles and away from other goods, resulting in inefficient domestic production
The triangle labeled ABC in panel (b) is the deadweight loss or excess burden resulting from the tariff

Argument for Protectionism

Protection saves jobs: foreign competition costs Americans their jobs, and victims of free trade can be aided constructively without forgoing the gains from trade
Some countries engage in unfair trade practices, and free trade may be the best solution when everybody plays by the rules
Cheap foreign labor makes competition unfair, but wages in a competitive economy reflect productivity, and trade flows according to comparative advantage
Protection safeguards national security: even if we acknowledge another country’s comparative advantage, we may want to protect our own resources

Additional Arguments for Protectionism

Protection discourages dependency: protecting industries in areas where a country has a comparative disadvantage may prevent trading relationships that might lead to political dependence
Environmental concerns: some environmental groups argue that free trade policies may harm the environment, and by imposing penalties on high-polluting products, the prices of goods imported this way would reflect the harm that those products cause
Protection safeguards infant industries: a young industry may need temporary protection from competition from the established industries of other countries to develop an acquired comparative advantage

International Trade and Comparative Advantage

Trade surplus: a situation when a country exports more than it imports
Trade deficit: a situation when a country imports more than it exports
Corn Laws: tariffs, subsidies, and restrictions enacted by the British Parliament in the early 19th century to discourage imports and encourage exports of grain
Theory of comparative advantage: Ricardo’s theory that specialization and free trade will benefit all trading partners (real wages will rise), even those that may be absolutely less efficient producers

Absolute and Comparative Advantage

Absolute advantage: an advantage in the production of a good enjoyed by one country over another when it uses fewer resources to produce that good than the other country does
Comparative advantage: an advantage in the production of a good enjoyed by one country over another when that good can be produced at a lower opportunity cost (in terms of other goods that must be forgone) than it could be in the other country

Trade Openness and Economic Consensus

Trade openness across the world has increased, with rapid reductions in tariffs in the last 25 years, especially in emerging and developing markets
According to the theory of comparative advantage, all countries benefit from specialization and trade: free international trade raises real incomes and improves the standard of living
Although protectionists argue for the protection of workers from foreign competition, it is unlikely to cause net job loss in an economy as workers are absorbed into expanding sectors over time

The Supply of Pounds in the Foreign Exchange Market

When the price of pounds rises, British buyers can obtain more dollars for each pound, making U.S.-made goods and services appear less expensive to them.
This increases the quantity of pounds supplied.

The Market for Foreign Exchange

The equilibrium exchange rate occurs when the quantity demanded of a foreign currency equals the quantity supplied.
Appreciation of a currency occurs when its value rises relative to another currency.
Depreciation of a currency occurs when its value falls relative to another currency.

Factors That Affect Exchange Rates

Purchasing power parity (PPP) theory states that exchange rates are set so that the price of similar goods in different countries is the same.
A high rate of inflation in one country relative to another puts pressure on the exchange rate, causing the currency of the high-inflation country to depreciate.

Exchange Rates Respond to Changes in Relative Prices

When the price level in one country increases, imports from another country become relatively less expensive, increasing the demand for the other country's currency.
The supply of the other country's currency shifts to the left, resulting in an appreciation of the currency.

Relative Interest Rates

When interest rates in one country rise relative to another, the supply of the other country's currency shifts to the right, causing its currency to depreciate.
The demand for the other country's currency shifts to the left, further depreciating the currency.

The Effects of Exchange Rates on the Economy

The level of imports and exports depends on exchange rates, income, and other factors.
Changes in exchange rates affect the levels of imports and exports, which in turn affect real GDP and the price level.

Import and Export Prices and the Price Feedback Effect

The price feedback effect occurs when a domestic price increase in one country drives up prices in other countries, further increasing the price level in the first country.

The Open Economy with Flexible Exchange Rates

Floating, or market-determined, exchange rates are determined by the unregulated forces of supply and demand.
Exchange rates adjust to changes in the economy, affecting the levels of imports and exports.

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This quiz covers the concept of oligopoly models, including the collusion model, cartel, and tacit collusion in microeconomics.