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use of economic concepts to describe the economy

1. Using the concepts of marginal costs and marginal revenues, explain why economic profits are maximized where marginal revenue equals marginal cost and why profits decline if the price is above or below the profit maximizing price.

2. Using the concepts of demand, supply, equilibrium, and price ceilings, explain why a shortage occurs when the price is too low (below equilibrium).

3. Using the concepts of supply, demand, equilibrium, shortages, surpluses, and price, explain why "price gouging" is not possible in economic theory.

4. Explain the difference between economic profits and accounting profits.

5. Using the concepts of relative elasticity and relative inelasticity, explain price elasticity of demand.

Solution Preview

1. Economic profits occur when total income exceeds total expenses, including opportunity costs. Marginal cost is the additional expense incurred when a company produces one additional unit of output. When this is less than the marginal revenue the company can earn from the unit, it is clearly not in the company's best interest to continue to produce. However, if the company can earn more income from an additional unit of output, it can earn greater profits by producing it. Therefore, companies will produce until MC=MR.

2. Supply and demand are in equilibrium when the price is such that the sellers are willing to produce as much as the buyers want to buy. If the price is higher, sellers will want to make more, but ...