ECON 101 - Midterm Exam #1

(Lesson 1 Lecture Notes) Economics is a ______ _______ that studies ___ ________ ______ ____ in order to _______ _____ ____/_____, given ______ __________.

1. social science

2. the choices people make

3. satisfy their needs/want

4. scarce resources

(Lesson 1 Lecture Notes) The two branches of economics are…

1. Microeconomics

2. Macroeconomics

(Lesson 1 Lecture Notes) The Two Branches of Economics

• What is MICROECONOMICS?

• the study of how households and businesses make choices, how they interact in markets, and how the government attempts to influence their choice

(Lesson 1 Lecture Notes) The Two Branches of Economics

• What is MACROECONOMICS?

• the study of how the individuals, firms and markets, or the economy, function together as a whole

(Lesson 1 Lecture Notes) Four Core Principles of Economics

• What is the OPPORTUNITY COST PRINCIPLE (or what?)?

• People must make choices and therefore face tradeoffs because resources are scarce.

• The true cost of something includes: its opportunity cost (the value of one’s next best alternative)

(Lesson 1 Lecture Notes) Four Core Principles of Economics

• What is the COST-BENEFIT PRINCIPLE (does the benefit outweigh the cost?)?

• Costs and benefits are incentives that shape decisions. You should always:

  • Evaluate the full set of costs and benefits associated with a choice

  • Pursue a choice only if the benefits outweigh the costs (these are rational choices)

(Lesson 1 Lecture Notes) Four Core Principles of Economics

• What is the MARGINAL PRINCIPLE (one more?)?

• Optimal “how much” decisions are made at the margin.

• Rational Rule: keep doing something until your marginal benefit equals your marginal cost

  • Ex> Should American Airlines offer to fly one more passenger to Dallas?

(Lesson 1 Lecture Notes) Four Core Principles of Economics

• What is the INTERDEPENDENCE PRINCIPLE (what else?)?

• Your best choice depends on:

  • your other choices

  • the choices others make

  • developments in other markets

  • expectations about the future

(Lesson 1 Lecture Notes) Economic Models

• What is an ECONOMIC MODEL?

• simplified representations of a real situation that is used to better understand real-life situations

(Lesson 1 Lecture Notes) Economic Models

• What is one key component of an economic model?

• simplifying assumptions

(Lesson 2: The PPF, Comparative Advantage, and Trade) Production Possibilities Frontier (PPF)

• What is the PRODUCTION POSSIBILITIES FRONTIER (PPF)?

• A curve showing the maximum amount one can produce given their resources and technology

(Lesson 2: The PPF, Comparative Advantage, and Trade) Production Possibilities Frontier (PPF)

• Draw the PPF for this table.

(Lesson 2: The PPF, Comparative Advantage, and Trade) Opportunity Cost

• What is OPPORTUNITY COST?

• The opportunity cost of producing one more unit of good x is the amount of good y you have to give up to get one more unit of good x.

(Lesson 2: The PPF, Comparative Advantage, and Trade) Extend Your Understanding

• Can you calculate the opportunity cost of a bike between points A and B? What is the opportunity cost of a case of beer?

(Lesson 2: The PPF, Comparative Advantage, and Trade) The Shape of the PPF

• Why does the PPF typically bow outward?

• the opportunity cost of producing one more unit of any good typically inreases the more you have of that good already

(Lesson 2: The PPF, Comparative Advantage, and Trade) The Shape of the PPF

• What would it mean if the PPF were linear?

• O_c = constant

(Lesson 2: The PPF, Comparative Advantage, and Trade) Economic Growth and the PPF

• Draw the effect on a PPF if there was an increase by 100 barbies and if everyone took a beer brewing class. Explain why this occurs.

• Changes in technology or increased resources will cause the PPF to shift outward

(Lesson 2: The PPF, Comparative Advantage, and Trade) Theory of Comparative Advantage

• What is ABSOLUTE ADVANTAGE?

• the ability to produce more of a good or a service than competitors when using the same amount of resources OR the ability to produce the same amount of output using fewer inputs

(Lesson 2: The PPF, Comparative Advantage, and Trade) Theory of Comparative Advantage

• What is COMPARATIVE ADVANTAGE?

• the ability to produce a good or service at a lower opportunity cost than competitors

• the theory of comparative advantage is one of task allocation: who should be doing what?

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

1. Step 1: Draw Production Possibilities Frontiers for you and your roommate.

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

2. Step 2: Calculate your opportunity costs and your roommates opportunity costs of baking pies and washing dishes.

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

• Who has the Absolute Advantage in washing dishes? Baking pies?

• Me!

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

• Who has the Comparative Advantage in washing dishes? Baking pies?

• Washing Dishes: roommate

• Baking Pies: me

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

• Assume that without trade, you decide to bake 2 pies in an hour and wash 20 dishes. Your roommate decides to bake 1 pie and wash 15 dishes. Without trade you can consume…

• what you produce → production = consumption w/o trade

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

3. Step 3: Specialization → One should specialize in producing the good in which one has the ___________ advantage. Production with trade is when one specializes in producing one good.

1. comparative

(Lesson 2: The PPF, Comparative Advantage, and Trade) Example

4. Step 4: Trade → If two parties decide to trade, they will set the price of good x _______ _____ _ ___________ ______ (____ __ __________ ___ ____ _____ __ ____ ____ ___ _____).

1. between their 2 opportunity costs (must be beneficial for each party or they will not trade)

(Lesson 2: The PPF, Comparative Advantage, and Trade) Prices

• To avoid having to barter, we use _____ as a ____ __ _______. For instance, if your time is worth $20 per hour and a pie costs $20, you would not be willing to buy that pie since you can bake 4 pies per hour, but if a pie costs $4, you will buy one.

1. money

2. unit of account

(Lesson 2: The PPF, Comparative Advantage, and Trade) Prices

• Prices serve as… which allows…

• Messages to buyers/sellers

• Incentives to buyers/sellers

• Bundles of info

→ This allows resources to be allocated to their most valuable uses and creates gains for all involved.

(Lesson 3 Notes: Demand, Supply, and Markets) Perfectly Competitive Markets

• What are the assumptions we make about perfectly competitive markets?

• All firms are selling identical goods/services (same Twix bar everywhere)

• No barriers to entry (everyone can sell/buy)

• Many rational buyers and sellers → everyone is a price-taker

(Lesson 3 Notes: Demand, Supply, and Markets) Perfectly Competitive Markets

• What are the 2 sides of the market?

1. CONSUMERS/BUYERS (demand)

2. SELLERS/PRODUCERS/FIRMS (supply)

(Lesson 3 Notes: Demand, Supply, and Markets) Building a Demand Curve Activity

• Draw a demand curve for this table.

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• What is QUANTITY DEMANDED?

• the amount of a good or service that customers are willing and able to buy at a particular price

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• What is DEMAND?

• the entire relationship between price and quantity demanded

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• What is a DEMAND SCHEDULE?

• a table that shows the relationship between the price and quantity demanded

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• What is a DEMAND CURVE?

• a curve that graphically represents the relationship between price and quantity demanded

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• What is MARKET DEMAND?

• The demand by all the consumers of a given good or service

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• What is THE LAW OF DEMAND?

• Ceteris Paribus (holding everything constant), as price increases, quantity demanded decreases

  • P↑ Q↓: negative relationship between p and q demanded or the demand curve is downward sloping

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• The Law of Demand: This is due to the substitution effect and the income effect. What is the SUBSTITUTION EFFECT?

• as price increases, people switch to consume relatively cheaper goods

(Lesson 3 Notes: Demand, Supply, and Markets) Demand Vocabulary

• The Law of Demand: This is due to the substitution effect and the income effect. What is the INCOME EFFECT?

• as price increase, people can afford less with the same amount of money

(Lesson 3 Notes: Demand, Supply, and Markets) If the price of a good changes, then ________ ________ changes / we ____ _____ the demand curve.

1. quantity demanded

2. move along

(Lesson 3 Notes: Demand, Supply, and Markets) Rational Rule for Buyers (price is given)

• Explain the RATIONAL RULE FOR BUYERS.

(Lesson 3 Notes: Demand, Supply, and Markets) Changes in Demand

• Draw the effect on the demand curve when demand increases and when demand decreases.

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Demand

• What are the determinants of demand?

1. Income

2. Prices of Related Goods

3. Tastes / Preferences

4. Expectations

5. Network Effects / Congestion Effects

6. # & Type of Customers

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Demand

• Explain INCOME.

• if income increases, ability to pay increases

• Normal Good: income increases → demand increases (Ex> restaurant Ramen)

• Inferior Good: income increases → demand decreases (Ex> packet Ramen)

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Demand

• Explain PRICES OF RELATED GOODS.

• Complements in Consumption:

  • Ex> Rum + Cake

• Substitutes in Consumption:

  • Ex> Pepsi + Coke

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Demand

• Explain EXPECTATIONS.

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Demand

• Explain NETWORK EFFECTS / CONGESTION EFFECTS.

• Network Effects: the more valuable the more people use them (Ex> Twitter → X; iPhones (less popular, less usage))

• Congestion Effects: less valuable the more people use them (Ex> long amusement park line → willingness to pay to go to park decreases)

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Demand

• Explain # & TYPE OF CUSTOMERS.

• more consumers = higher demand (less consumers = lower demand)

(Lesson 3 Notes: Demand, Supply, and Markets) Individual Versus Market Demand

• Assume there are only 2 consumers in the market for candy bars. The table below represents their individual demand for candy bars. Determine the market quantity demanded and draw the individual and market demand curves.

(Lesson 3 Notes: Demand, Supply, and Markets) Extend Your Understanding

• When Apple released the iPhone 5, prices for iPhone 4 and below decreased drastically. How might this change in price of the iPhone 4 affect demand for iPhone 30-pin chargers that are only compatible with the iPhone 4 and below?

• Since the price of the iPhone 4 is cheaper, its demand will increase and since the iPhone 4 and the iPhone 30-pin chargers are complementary goods, the demand of the chargers will increase too.

(Lesson 3 Notes: Demand, Supply, and Markets) Labor Supply Activity

• Explain what the graph shows. Given your current class schedule and other commitments (there are 40 hours in a typical workweek, about 110 hours in a week if you sleep 8 hours per day, and 168 hours in a week maximum):

• $ goes up, you’re willing to work more

(Lesson 3 Notes: Demand, Supply, and Markets) Labor Supply Activity

• Explain what the graph shows.

• # of people willing to sing song decreases as price goes down

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• What is QUANTITY SUPPLIED?

• The amount of a good or service that a firm is willing and able to supply at a given price

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• What is SUPPLY?

• the entire relationship between price and quantity supplied

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• What is a SUPPLY SCHEDULE?

• a table that show the relationship between the price and quantity supplied

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• What is a SUPPLY CURVE?

• the graphical representation of the relationship between price and quantity supplied

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• What is MARKET SUPPLY?

• the quantity supplied by all firms at each price

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• Explain the RATIONAL RULE FOR SELLERS.

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• What is the LAW OF SUPPLY?

• Ceteris Paribus (holding everything constant), as price increases, quantity supplied increases

  • P↑ Q^s↑: positive relationship between price and quantity or supply curve slopes upward

(Lesson 3 Notes: Demand, Supply, and Markets) Supply Vocabulary

• Law of Supply: Why does supply slope upward?

• higher market prices give produces a stronger incentive to make and sell more of a good to maximize their profit

(Lesson 3 Notes: Demand, Supply, and Markets) If the price of a good changes, then ________ ________ changes/we ____ _____ the supply curve.

1. quantity supplied

2. move along

(Lesson 3 Notes: Demand, Supply, and Markets) Changes in Supply

• Draw the effect on the supply curve when supply increases and when supply decreases.

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Supply

• What are the determinants of supply?

1. prices of inputs

2. technological change / changes in human capital (knowledge + skills)

3. prices of complements / substitutes in production

4. expected future prices

5. # / type of sellers

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Supply

• Explain PRICES OF INPUTS.

• when the price of cocoa increases, the supply of candy bars decreases

• when the price of cocoa decreases, the supply of candy bars increases

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Supply

• Explain TECHNOLOGICAL CHANGE / CHANGES IN HUMAN CAPITAL.

• if machine and/or workers become more productive (can produce more with same resources), marginal cost decreases and supply will increase

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Supply

• Explain PRICES OF COMPLEMENTS / SUBSTITUTES IN PRODUCTION.

• Complements in Production: if the price of ice cream increases, the supply of skim milk will increase

• Substitutes in Production: if the price of truffles increases, the supply of candy bars will decrease

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Supply

• Explain EXPECTED FUTURE PRICES.

(Lesson 3 Notes: Demand, Supply, and Markets) Determinants of Supply

• Explain # / TYPE OF SELLERS.

• when the number of sellers increases, supply will increase

(Lesson 3 Notes: Demand, Supply, and Markets) Individual Versus Market Supply (hor. sum of individual supply)

• Assume there are only two firms that produce candy bars, Wonka’s and Mars’ candy companies. The table below represents their individual supply schedules. Determine the market quantity supplied and then draw the individual and market supply curves.

(Lesson 3 Notes: Demand, Supply, and Markets) Extend Your Understanding

• Electronics manufacturers can either make iPhone chargers or android chargers. If the price of iPhone chargers decreases, what happens to the supply of iPhone chargers?

• price of iPhone chargers decreases → quantity supplied decreases → move down/left along supply curve

• supply curve itself stays in same place

(Lesson 3 Notes: Demand, Supply, and Markets) Market Equilibrium

• What does it mean for a market to be in equilibrium?

• demand + supply = market

• when quantity demanded = quantity supplied… plans of buyers line up w/ plans of sellers

• @ P*, Q^D = Q^S = Q*

(Lesson 3 Notes: Demand, Supply, and Markets) Market Equilibrium

• What are the three ways to find market equilibrium?

1. From demand + supply schedules

   1. at which P does Q^D = Q^S

2. Graphically

1. Algebraically

   1. set Q^D and Q^S = and solve for P^* and Q⁸

(Lesson 3 Notes: Demand, Supply, and Markets) Market Adjustments (The Invisible Hand)

• What is P>P*?

(Lesson 3 Notes: Demand, Supply, and Markets) Market Adjustments (The Invisible Hand)

• What is P<P*?

(Lesson 3 Notes: Demand, Supply, and Markets) Determining the Effect of an Event on a Market

1. Does the event affect supply, demand, or both?

2. Does this cause an increase or a decrease?

3. What happens to P* and Q*?

(Lesson 3 Notes: Demand, Supply, and Markets)

• changes in demand = ____ direction P* & Q*

1. same

(Lesson 3 Notes: Demand, Supply, and Markets)

• changes in supply = ____ direction P* & Q*

1. opposite

(Lesson 4: Economic Surplus and Efficiency) Demand & MB

• Explain the difference between VALUE and PRICE.

• Value: the benefit a person gets from consuming a good or service

• Price: what people pay to consume a good or service

(Lesson 4: Economic Surplus and Efficiency) Demand & MB

• D _ WTP (willingness to pay) _ MB (marginal benefit)

1. =

2. =

(Lesson 4: Economic Surplus and Efficiency) Demand & MB

• Explain what’s shown by this graph.

• value goes down as you consume more

(Lesson 4: Economic Surplus and Efficiency) Consumer Surplus (CS)

• What is CONSUMER SURPLUS?

• the difference between what you are willing to pay and what you actually pay for a good/service

• the area above P and below the MB curve for all goods/services consumed

• CS = WTP - P or = MB - P

(Lesson 4: Economic Surplus and Efficiency) Consumer Surplus (CS)

• The demand for candy bars can be represented by the following equation: P = 5 - Q^D/10. If P* = 1, what is the consumer surplus in the market?

(Lesson 4: Economic Surplus and Efficiency) Supply & MC

• S _ MC (marginal cost)

1. = (firms need to sell at a price that is at least what it costs them to produce the good or service)

(Lesson 4: Economic Surplus and Efficiency) Producer Surplus (PS)

• What is PRODUCER SURPLUS?

• the difference between the price sellers receive for a good or service and how much it costs to make it (the difference between the lowest price a firm would be willing to accept for a good or service (MC) and the price it actually receives)

• the area beneath P and above MC curve for all Q sold

• PS = P - MC

(Lesson 4: Economic Surplus and Efficiency) Producer Surplus (PS)

• If the supply curve for candy bars can be represented by the following equation: P = Q^S/40. If P* = 1, what is the producer surplus?

• $20

(Lesson 4: Economic Surplus and Efficiency) Total Surplus (TS)

• What is TOTAL SURPLUS?

• total benefit to society from the production and consumption of a good or service

• TS = CS + PS = MB - MC for all goods bought and sold

  • (MB - P) + (P - MC)

(Lesson 4: Economic Surplus and Efficiency) Example

• Consider the market for candy bars represented by the supply and demand equations below: P = 5 - Q^D/10 & P = Q^S/40. What is the economic surplus in this market in equilibrium?

• $100

(Lesson 4: Economic Surplus and Efficiency) The Rational Rule for Markets

• Produce more of a good if its marginal benefit (MB) is _______ ____ __ _____ to its marginal cost (MC). Why?

1. greater than or equal

2. Why? → b/c MB > MC tells us economic surplus will increase if we produce more

(Lesson 4: Economic Surplus and Efficiency) Economic Efficiency

• When does ECONOMIC EFFICIENCY occur?

• occurs when the marginal cost of producing the last unit of a good is exactly equal to the marginal benefit from consuming it and where the economic surplus (net benefits to society) is maximized

(Lesson 4: Economic Surplus and Efficiency) Economic Efficiency

• If an outcome is efficient, ________ _______ is maximized.

1. economic surplus

(Lesson 4: Economic Surplus and Efficiency) Economic Efficiency

• Market equilibrium in a perfectly competitive market is ____________ _________ (aka ___ _________ ______).

1. economically efficient

2. the efficient outcome

(Lesson 4: Economic Surplus and Efficiency) Example

• Consider the market for candy bars represented by the supply and demand equations below: P = 5 - Q^D/10 & P = Q^s/40. If P = $2 in the market for candy bars, identify the areas that represent economic surplus.

(Lesson 4: Economic Surplus and Efficiency) Example

• Consider the market for candy bars represented by the supply and demand equations below: P = 5 - Q^D/10 & P = Q^s/40. If P = $2 in the market for candy bars, identify the areas that represent economic surplus.

  • Where is the quantity bought and sold (Q_B)?

• min (Q^D, Q^S)

(Lesson 4: Economic Surplus and Efficiency) Deadweight Loss

• Deadweight loss (DWL) is created when the market is ___ _________ ___ _________ _______. There is ___ whenever the market is not at the efficient outcome.

1. not producing the efficient quantity (DWL = TS_{efficient outcome} - TS_{inefficient outcome})

2. DWL (DWL = MB - MC for all goods being under (or over) produced relative to the efficient Q)

(Lesson 4: Economic Surplus and Efficiency) Market Failure

• Market failure occurs when the forces of supply and demand lead to an ___________ _______.

1. inefficient outcome

(Lesson 4: Economic Surplus and Efficiency) Market Failure

• What are the five sources of market failure?

1. Market Power

2. Externalities

3. Private Info

4. Irrationality

5. Government Regulations (sometimes, not always)

(Lesson 4: Economic Surplus and Efficiency) Moving Forward: Evaluating Policies

• What is *POSITIVE ANALYSIS?

• describes what is happening, explaining why, or predicting what will happen

(Lesson 4: Economic Surplus and Efficiency) Moving Forward: Evaluating Policies

• What is NORMATIVE ANALYSIS?

• prescribes what SHOULD happen, which involves value judgements

(Lesson 4: Economic Surplus and Efficiency) Efficiency vs. Equity

• What is EFFICIENCY?

• maximizing benefits that can be created (size of pie)

(Lesson 4: Economic Surplus and Efficiency) Efficiency vs. Equity

• What is EQUITY?

• how pie is divided