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LAW OF DIMINISHING MARGINAL RETURNS: A principle stating that as more and more of a variable input is combined with a fixed input in short-run production, the marginal product of the variable input eventually declines. This is THE economic principle underlying the analysis of short-run production for a firm. Among a host of other things, it offers an explanation for the upward-sloping market supply curve. How does the law of diminishing marginal returns help us understand supply? The law of supply and the upward-sloping supply curve indicate that a firm needs to receive higher prices to produce and sell larger quantities. Why do they need higher prices?

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Lesson 7: Market Equilibrium | Unit 4: Adjustment Page: 16 of 22

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  • How competitive markets tend to be self-correcting because nonequilibrium prices create shortages and surpluses that move the price back to the equilibrium level.
  • How shortages, with quantity demanded greater then quantity supplied, are created for prices below the equilibrium level.
  • 3. Why a shortage causes price to increase back to the equilibrium level.
  • How surpluses, with quantity demanded less then quantity supplied, are created for prices above the equilibrium level.
  • Why a surplus causes price to decrease back to the equilibrium level.


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SHUTDOWN RULE

A rule stating that a firm minimizes economic loss by producing no output in the short run if price is less than average variable cost. This is one of three short-run production alternatives facing a firm. The other two are profit maximization (if price exceeds average total cost) and loss minimization (if price is less than average total cost but greater than average variable cost).

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