Deck 12: General Equilibrium and the Efficiency of Perfect Competition

Question 1

Use Figure 12.1 to answer the following question. Assume that this industry is currently enjoying normal economic profit and for whatever reason there is an increase in demand for the goods produced by this industry. Using general equilibrium analysis explain what will happen both in this industry and in industry Y which is perceived by consumers as being a product that is a substitute for product X.

Answer 1

Initially, demand for X shifts from to This shift pushes the price of X up to creating profits. Demand for Y shifts down from to pushing the price of Y down to and creating losses. Firms have an incentive to leave sector Y and an incentive to enter sector X. Exiting sector Y shifts supply in that industry to raising price and eliminating losses. Entry shifts supply in X to S1 thus reducing and eliminating profits.

Question 2

What does it mean for an industry to be considered an increasing cost industry?

Answer 2

An increasing cost industry is one where resource prices rise as the size of the industry expands.

Question 3

What is efficiency?

Answer 3

Efficiency is the condition in which the economy is producing what people want at the least possible cost.

Question 4

Why are perfectly competitive markets considered efficient?

Question 5

In the early years of software development the industry had to train its own workers in developing code to build software applications. It was a very costly undertaking as software firms had to shoulder most of the training costs. However, over time the industry began to experience decreasing costs. How and why did this transformation take place?

Question 6

Comment on the following statement: "Input and output markets should be considered separately because they operate independently of one another."

Question 7

Comment on the following statement. "Once general equilibrium is achieved this will result in a long-run equilibrium as well."

Question 8

How is it that economists can claim that perfectly competitive markets give people what they want?

Question 9

What assumptions lead to the conclusion that final products are distributed efficiently among households?

Question 10

Explain the difference between partial equilibrium analysis and general equilibrium analysis.

Question 11

What assumptions lead to the conclusion that that the allocation of resources among firms is efficient.

Question 12

What is partial equilibrium analysis?

Question 13

Assume that the economy has two sectors, milk and orange juice, and that both sectors are initially in long-run competitive equilibrium. Milk and orange juice are substitute goods. Trace the effects of a change in preferences that increases the demand for orange juice.

Question 14

What three decisions do firms make simultaneously?

Question 15

Assume that a farmer could just as easily plan corn as well as wheat. Explain what would happen using a supply and demand graph for both markets if suddenly there was a sustained increase in the demand for corn.

Question 16

The text asserts that the allocation of resources among firms is efficient. What assumptions must hold for this to be true?

Question 17

Why is it difficult to determine whether an industry is operating efficiently when there is rapid technological process underway?

Question 18

If all the assumptions of perfect competition hold, the result is an efficient, or Pareto optimal, allocation of resources. What is necessary to prove this?

Question 19

Would the housing industry be characterized as an increasing, decreasing or a constant-cost industry? Explain your position.

Question 20

What is general equilibrium?

Question 21

A firm produces an output level at which price is greater than marginal cost. Explain why this is inefficient.

Question 22

Antitrust cases that are brought to the courts by the Justice Department typically rely on perfect competition as a benchmark for lawyers to determine whether a firm is competitive or monopolistic. Why is this a troublesome criterion to use in prosecuting such cases?

Question 23

Assume there is a toll bridge that is built by a private firm. It's been determined by cost accountants that the marginal cost that each automobile imposes is close to zero. If the bridge cost $1 million to build and 250,000 automobiles cross it each day what is the price that would be necessary for the firm to charge in order to achieve the key efficiency criteria of perfect competition? How might this be a problem for this private bridge company?

Question 24

Is it theoretically possible for general equilibrium to be attained? Is it likely that general equilibrium will be attained? Explain.

Question 25

Why does the model of perfect competition imply that firms will produce the products that households want the most?

Question 26

Why does the model of perfect competition imply that there will be an efficient allocation of resources among firms?

Question 27

Why does an efficient distribution of outputs among households occur in perfectly competitive markets?

Question 28

Create an example of a Pareto efficient trade. Make sure that you explain why such a trade is Pareto efficient.

Question 29

What condition must be satisfied so that society is producing the efficient mix of output? Why does this condition guarantee efficiency?

Question 30

What is Pareto optimality?

Question 31

If the economy were truly made of industries that fit the textbook definition of perfect competition what do you expect would be a major disadvantage of this from the consumer's perspective?

Question 32

Use the three basic questions to describe why perfect competition is efficient.

Question 33

When parents inoculate their children from communicable diseases prior to sending them off to school they not only provide their own children a benefit but also bestow a benefit on every other student at the school. There are now fewer students who can pass on these types of diseases. However, parents are not likely to take into account the fact that their actions create this external benefit. Therefore, economists argue that the market on its own may not provide for the optimal level of inoculations. What methods might work to get parents to take into account the external benefit when deciding whether to inoculate their children?

Question 34

What three assumptions must hold for the allocation of resources among firms to be efficient?

Question 35

Create an example of a trade that is not Pareto efficient. Make sure that you explain why such a trade is not Pareto efficient.

Question 36

What are the three basic economic questions that must be answered by all societies?

Question 37

Define public goods. Give an example of a public good. Explain why private firms will not generally produce public goods.

Question 38

Students arriving late to class are a potential negative externality because their tardiness may interrupt the instructor and distract students. Can you think of any way in which this externality could be curbed? That is, can you think of any methods that could be employed to internalize this negative externality?

Question 39

How is a potentially efficient change different from a Pareto optimal change?

Question 40

Do the assumptions of the perfectly competitive model describe all real-world markets? Explain.

Question 41

What is meant by market failure?

Question 42

Explain the condition where society would be better off when more of a good is produced.

Question 43

What is imperfect competition?

Question 44

Define "externality." Give an example of an external cost. Explain why resources will not be allocated efficiently if externalities are present. How can the problem of externalities be addressed?