Econ Exam

[W1] What is the cost-benefit principle?

Choose an action when its additional benefits exceed its additional costs. Include relevant monetary and non-monetary costs and benefits.

[W1] What is opportunity cost?

The value of the next best alternative forgone when making a choice. It is not the sum of every alternative.

[W1] What is the marginal principle? Compare the additional benefit (MB) and additional cost (MC) of one more unit. Continue while MB exceeds MC; stop when the next unit’s MC exceeds its MB.

[W1] What is economic surplus from a decision?

The benefit received minus the relevant cost. A positive surplus indicates that the benefit exceeds the cost.

[W1] What is consumer surplus for one purchase?

The buyer’s willingness to pay minus the actual price paid.

[W1] What is producer surplus for one sale?

The price received by the seller minus the seller’s minimum acceptable price or opportunity cost of supplying that unit.

[W1] What is total economic surplus from a voluntary trade?

Consumer surplus plus producer surplus; equivalently, the buyer’s willingness to pay minus the seller’s opportunity cost.

[W1] What is a sunk cost?

A cost already incurred that cannot be recovered. It should not affect a decision about future actions, although future avoidable costs and benefits do matter.

[W1] What is the framing effect?

When the way a choice is presented affects a decision, even though the underlying relevant costs and benefits are unchanged.

[W1] What is the interdependence principle?

One person’s decisions affect others, and those effects can feed back into the original decision-maker’s incentives and choices.

[W2] What is the law of demand?

Other things equal, when a good’s own price rises, its quantity demanded falls; when its price falls, quantity demanded rises.

[W2] What is the difference between demand and quantity demanded?

A change in the good’s own price causes movement along an existing demand curve. A change in another determinant, such as income or preferences, shifts the entire demand curve.

[W2] What can shift demand?

Changes in income, preferences, the number of buyers, expectations, or the prices of related goods such as substitutes and complements.

[W2] What is a normal good?

A good for which demand increases when consumer income increases, other things equal.

[W2] What is an inferior good?

A good for which demand decreases when consumer income increases, other things equal.

[W2] What are substitutes?

Goods that can be used in place of each other. A rise in the price of one tends to increase demand for the other.

[W2] What are complements?

Goods consumed together. A rise in the price of one tends to decrease demand for the other.

[W2] What is the law of supply?

Other things equal, when a good’s own price rises, quantity supplied tends to rise; when its price falls, quantity supplied tends to fall.

[W2] What is the difference between supply and quantity supplied?

A change in the good’s own price causes movement along the supply curve. A change in another determinant, such as input costs, shifts the supply curve.

[W2] What can shift supply?

Changes in input prices, technology, taxes, subsidies, expectations, the number of sellers, or production conditions such as weather.

[W2] How do higher input costs affect supply?

They generally decrease supply: the supply curve shifts left or upward. With demand unchanged, equilibrium price rises and equilibrium quantity falls.

[W2] What is the rational rule for buyers?

Buy another unit if its marginal benefit is at least as large as its marginal cost; stop before a unit whose marginal benefit is below its marginal cost.

[W2] What is the rational rule for sellers?

In the basic model, supply additional units while the additional revenue from selling a unit is at least as great as the marginal cost of producing it.

[W2] What is marginal cost?

The additional cost of producing one more unit: change in total cost divided by change in quantity.

[W2] What is marginal benefit?

The additional benefit from consuming or undertaking one more unit: change in total benefit divided by change in quantity.

[W3] What is market equilibrium?

The price and quantity at which quantity demanded equals quantity supplied, assuming a competitive market with no binding restriction.

[W3] What is a shortage, and what pressure does it create?

At a given price, quantity demanded exceeds quantity supplied. Without a binding restriction, the shortage puts upward pressure on price.

[W3] What is a surplus, and what pressure does it create?

At a given price, quantity supplied exceeds quantity demanded. Without a binding restriction, the surplus puts downward pressure on price.

[W3] What happens when demand increases and supply is unchanged?

The demand curve shifts right; equilibrium price and equilibrium quantity both rise.

[W3] What happens when demand decreases and supply is unchanged?

The demand curve shifts left; equilibrium price and equilibrium quantity both fall.

[W3] What happens when supply increases and demand is unchanged?

The supply curve shifts right; equilibrium price falls and equilibrium quantity rises.

[W3] What happens when supply decreases and demand is unchanged?

The supply curve shifts left; equilibrium price rises and equilibrium quantity falls.

[W3] What happens if demand increases and supply decreases simultaneously?

Equilibrium price rises. The effect on equilibrium quantity is ambiguous unless we know the relative sizes of the shifts.

[W3] What happens if demand and supply both increase?

Equilibrium quantity rises. The effect on equilibrium price is ambiguous without information about the relative sizes of the shifts.

[W3] How should you analyse a supply-and-demand scenario?

Identify the market; decide which curve shifts and why; state the direction of the shift; compare the original and new equilibria; and explain any ambiguity or assumptions.

[W3] Why is a price rise alone not necessarily a demand increase?

A price rise could result from reduced supply. A higher price also causes a movement along the demand curve, reducing quantity demanded, without necessarily shifting demand.

[W4] What is price elasticity of demand (PED)?

The percentage change in quantity demanded divided by the percentage change in the good’s own price, holding other factors constant. It measures price responsiveness.

[W4] How do you calculate and classify PED?

PED = % change in quantity demanded / % change in price. Use its absolute value: below 1 is inelastic, above 1 is elastic, and exactly 1 is unit elastic.

[W4] If price rises by 10% and quantity falls by 4%, what is the observed ratio?

−4% / 10% = −0.4; its absolute value is 0.4, so the observed response is inelastic. It is a causal PED estimate only if other relevant factors are appropriately controlled.

[W4] What makes demand more price-elastic?

More close substitutes, a larger share of the consumer’s budget, a more narrowly defined product, and often more time to adjust.

[W4] What makes demand more price-inelastic?

Few close substitutes, a necessity, a small share of income, and often a short adjustment period.

[W4] How does a price increase affect total revenue when demand is inelastic?

Total revenue generally rises because the percentage fall in quantity is smaller than the percentage rise in price, assuming the relevant elasticity applies.

[W4] How does a price increase affect total revenue when demand is elastic?

Total revenue generally falls because the percentage fall in quantity is greater than the percentage rise in price, assuming the relevant elasticity applies.

[W4] What is price elasticity of supply (PES)?

The percentage change in quantity supplied divided by the percentage change in price. It measures how responsive sellers are to a price change.

[W4] Why might supply become more elastic over time?

Firms may have more time to hire workers, expand capacity, invest in equipment, or enter the market.

[W4] What is a price ceiling?

A legally imposed maximum price. It is binding when set below the market equilibrium price.

[W4] Why might a government introduce a price ceiling?

To make a good or service more affordable for buyers. For example, a rent ceiling may reduce the rent paid by tenants who secure housing.

[W4] What does a binding price ceiling predict in the basic model?

At the controlled price, quantity demanded exceeds quantity supplied, creating a shortage. Actual sales are constrained by available supply.

[W4] How do you calculate a shortage?

Shortage = quantity demanded − quantity supplied at the controlled price. For example, 1,200 − 900 = 300 units.

[W4] What is a price floor?

A legally imposed minimum price. It is binding when set above the market equilibrium price.

[W4] Why might a government introduce a price floor?

To support sellers’ prices or workers’ wages. However, a higher price per unit does not guarantee every seller can sell all they wish to sell.

[W4] What does a binding price floor predict in the basic model?

At the controlled price, quantity supplied exceeds quantity demanded, creating a surplus unless another mechanism, such as government purchasing, changes the outcome.

[W4] How do you calculate a surplus caused by a price floor?

Surplus = quantity supplied − quantity demanded at the controlled price.

[W4] What is the difference between quantity demanded and quantity actually sold under a binding ceiling?

Quantity demanded is what buyers want at the controlled price. In the basic model, actual sales are limited by the smaller quantity supplied.

[W4] What does the basic competitive model predict about a binding minimum wage?

It can create a labour surplus if labour supplied exceeds labour demanded. Real-world employment effects depend on conditions, including employer market power, and are not automatically negative.

[W5] What is an efficient allocation in the basic market model?

An allocation that maximises total surplus. For the final unit produced, marginal social benefit equals marginal social cost under the model’s assumptions.

[W5] How do you identify consumer surplus on a graph?

The area below the demand curve and above the price paid by consumers, up to the quantity actually traded.

[W5] How do you identify producer surplus on a graph?

The area above the supply curve and below the price received by producers, up to the quantity actually traded.

[W5] How do you calculate the area of a surplus triangle?

Area = ½ × base × height. Use the appropriate quantity interval as the base and the price or marginal-value difference as the height.

[W5] What is deadweight loss (DWL)?

The loss of total surplus from mutually beneficial activity that does not occur, or from activity whose social cost exceeds its social benefit.

[W5] What is market failure?

A situation in which a market allocation does not maximise net social benefits. Possible causes include externalities, public goods, market power and information problems.

[W5] What is an externality?

A cost or benefit imposed on a third party by an economic activity that is not fully reflected in the decision-maker’s private incentives.

[W5] What is a negative production externality?

A cost imposed on third parties by production, such as pollution harming nearby residents. Marginal social cost exceeds marginal private cost.

[W5] What is the relationship between MSC, MPC and MEC?

Marginal social cost = marginal private cost + marginal external cost. If marginal external cost is positive, MSC exceeds MPC.

[W5] What quantity does a market produce with an uncorrected negative production externality?

In the standard competitive model, market quantity exceeds the socially efficient quantity because producers do not account for all external costs.

[W5] What is a positive consumption externality?

A benefit to third parties from consumption, such as some benefits of vaccination to other people. Marginal social benefit exceeds marginal private benefit.

[W5] What is the relationship between MSB, MPB and MEB?

Marginal social benefit = marginal private benefit + marginal external benefit. If the external benefit is positive, MSB exceeds MPB.

[W5] What quantity does a market provide with an uncorrected positive consumption externality?

In the standard model, market quantity is below the socially efficient quantity because consumers do not account for all the benefits to others.

[W5] What is a Pigouvian or corrective tax?

A tax designed to make decision-makers face an external cost. In the simple model, a per-unit tax equal to marginal external cost at the socially efficient quantity can lead to the efficient quantity.

[W5] How can a government respond to a positive externality?

It may consider a subsidy, public provision or another policy that encourages the activity. The best approach depends on costs, benefits and implementation.

[W5] What is an internality?

A cost or benefit a person imposes on their future self that they do not adequately account for when making a decision; it differs from an externality affecting third parties.

[W5] Why can publicly funded healthcare create a potential consumption externality?

If an activity contributes to illness and some treatment costs are borne by other people through public funding, that portion may be an external cost. The consumer’s own illness is a private cost.

[W5] What happens when a per-unit tax is imposed on sellers?

In the standard competitive model, supply shifts upward by the tax amount; the buyer’s price generally rises, the seller’s net price generally falls, and quantity traded generally falls.

[W5] What is the tax wedge?

The difference between the buyer’s price and the seller’s after-tax price. It equals the tax per unit.

[W5] What is tax incidence?

The division of the economic burden of a tax between buyers and sellers, regardless of which side is legally required to remit it.

[W5] Which side generally bears more of a tax?

The relatively less price-elastic side bears the larger share in the standard model. Both demand and supply elasticities matter.

[W5] How do you calculate the buyer’s and seller’s tax burden per unit?

Buyer burden = buyer’s after-tax price − original price. Seller burden = original price − seller’s after-tax net price. The two burdens add up to the tax per unit.

[W5] How do you calculate government tax revenue?

Tax per unit × quantity actually sold after tax. On the diagram it is the rectangle between buyer and seller prices, from zero to the after-tax quantity.

[W5] How do you calculate tax-related DWL with linear curves?

½ × tax per unit × reduction in quantity. In the basic no-externality model, this is the triangle between original demand and supply from the after-tax to the original quantity.

[W5] Why does the usual tax-DWL conclusion need qualification when there is an externality?

A corrective tax can reduce an existing external cost and move output towards the social optimum. Its overall welfare effect cannot be assessed using only private surplus.

[W6] What is a market structure?

The organisation of a market, including the number of firms, product differentiation, barriers to entry, information and the degree of market power.

[W6] What is perfect competition?

A model with many buyers and sellers, homogeneous products and low barriers to entry. Individual firms are price takers and cannot independently set the market price.

[W6] What is a monopoly?

A market with one seller and significant barriers to entry, giving the firm market power over price, subject to demand.

[W6] What is monopolistic competition?

A market with many firms selling differentiated products and relatively low entry barriers. Firms have some pricing power because products are not identical.

[W6] What is an oligopoly?

A market dominated by a small number of firms whose decisions can affect one another. Strategic interdependence is important.

[W6] What is market power?

The ability of a firm to influence the price it charges, rather than taking the market price as given.

[W6] Why can a monopoly create deadweight loss?

Compared with the competitive benchmark, an unregulated profit-maximising monopoly can restrict output and charge a higher price, leaving some mutually beneficial trades unrealised.

[W6] What output rule does a profit-maximising firm use?

Choose the output where marginal revenue equals marginal cost, when producing is worthwhile and the standard assumptions apply.

[W6] What is the difference between economic profit and accounting profit?

Accounting profit subtracts explicit costs from revenue. Economic profit also subtracts relevant implicit opportunity costs.

[W6] What are barriers to entry?

Factors that make it difficult for new firms to enter a market, such as large initial costs, legal protections, control of essential inputs or network effects.

[W6] What is price discrimination?

Charging different customers different prices for the same or similar good when the price differences are not solely explained by differences in cost.

[W6] What conditions make price discrimination possible?

A firm generally needs market power, a way to identify or separate customers by willingness to pay, and some ability to limit resale.

[W6] Why might airlines charge different fares for the same flight?

Customers have different willingness to pay and booking flexibility. Airlines use fare rules and revenue management, although demand, capacity and costs also influence prices.

[W6] Does a price difference always prove price discrimination?

No. Different prices can also reflect differences in cost, quality, timing, availability or other conditions.

[W7] What is game theory?

The study of strategic decisions where each player’s best action depends on what other players do.