Econ 2001.01 Final Exam OSU

Economics

How to allocate the scarce or limited natural resources of the world so as to best meet the unlimited wants of human beings

Technical Efficiency

Producing an output with the least amount of inputs.

Economic Efficiency

Producing an output with the least amount of costs.

Resources

Land, Labor, Capital, Entrepreneurship

Returns on resources (Land)

Land - Rent

Returns on resources (Labor)

Labor - (wages + salaries)

Returns on resources (Capital)

Capital - Intrest

Returns on resources (Entrepreneurship)

Entrepreneurship - Profit

Commodities

Both tangible and intangible services

Basic Economic Questions

What? How? For whom?

Answer to baisic economic questions

Free markets -> price system

Why do we have a "Mixed Economy"?

Free and unregulated markets were not giving "right" answer.

Monopoly Influences - distort the allocative function of prices

Competitive assumption

Normative statements

Value Judgements

Positive Statements

Statements of Fact

Truth or falsehood can be determined empirically

Scientific Method

Means of looking at real-world data

Regression analysis

Tests to see if there is a relationship between two or more variables

What is the opportunity cost if a person takes a gap year after graduation when they have an offer for $40,000?

$40,000

Opportunity Cost

What you give up in foregone alternatives when any action is taken. OR The Next Best Alternative OR Next Highest-Valued Alternative

Production Possibility Frontier

A table or graph showing what an economy can produce. ex

Gun Butter

10 0

8 2

6 4

4 6

2 8

0 10

Marginal Cost

Opportunity cost of producing another increment of a commodity in a PPF.

Marginal

Refers to the last extra increment in something

Shape of a real-life PPF

Bowed-out or concave downward

this is because resources are not all perfect substitutes in the production of both commodities

What does a straight PPF graph show?

Constant Opportunity Cost

Principle of Decreasing Marginal Benefit

The more we have of the commodity, the less we benefit from getting an additional unit and the less we are willing to pay to get an additional unit.

Marginal Benefit

Benefit we get from consuming one more unit of a commodity. Measured by a person's willingness to pay to pay for an additional unit of a commodity.

Willingness to pay (marginal benefit)

Presumably consumer is willing to pay what the item is worth to them so "willingness to pay" measures marginal benefit

What is the "ultimate question"?

Where should we be on the PPF?

Answer to "ultimate question"?

Point at the intersection of Marginal cost and marginal benefit. Point where allocative efficiency aligns with the intersection of MC and MB

Being on the PPF means?

Production efficiency is achieved

If MC > MB on PPF? What Direction is it on the graph?

We should cut back on butter production. It is right of intersection.

If MB > MC on PPF? What Direction is it on the graph?

We should increase butter production. It is left of the intersection.

What is happening is a point is inside the PPF?

There is unemployment

What happens to PPF with economic growth?

Moves outward

Three main macroeconomic goals of the economy

Full employment, price stability, economic growth

Comparative advantage

you can produce it more cheaply relative to another good- i.e., at a lower opportunity cost - than someone else.

Absolute advantage

You produce more cheaply.

Ex. The US has absolute advantage over Canada in corn, Canada has absolute advantage in wheat over the US

Product Wheat Corn

US 6 15

Canada 8 12

Production without specialization

When two nations (ex US and Canada) both produce the same two goods instead of the one good that they have the absolute advantage in. in Corn wheat example US and Canada produce 14 wheat and 27 corn without specialization. With specialization they produce 16 wheat and 30 corn.

Circular flow (Factor market)

Money flows from firms to households, Goods and services flow from households to firms

Circular flow (Goods market)

Money flows from households to firms, goods and services flow from firms to households.

Three ways to represent demand

Schedule, graph, equation

As price increases quantity demanded....

decreases

Demand equation

Q=f(P)

Q is dependent variable

P is independent variable

P and Q move in opposite directions

Curve is downward sloping

Quantity demanded v Demand

Quantity demanded is any specific point on the demand curve

Change in quantity demanded

A movement along a single demand curve - results from a change in price

Change in demand

is a shift of the entire demand curve - results from a change in demand shift factor

Demand shifters

Prices of related products (Substitutes and compliments), expected future prices, Income, Expected income and credit, Population, and Preferences

Substitutes

Goods consumed instead of another (eg. coke v pepsi)

Compliments

Good consumed together (eg. Coffee and sugar)

Expected future prices effect on demand

If you expect the price of a good to rise in the future, you will retime your purchase and buy more of it now and vise versa.

Income (Normal Commodities)

When income rises, demand increases and vice versa

Income (Inferior Commodities)

When income rises, demand decreases and vise versa (Eg. Hamburger Helper)

Population

increasing population shifts demand curve right

Prefrences

Increasing preferences or tastes for a commodity shifts curve rightward

Ways to represent supply

Schedule, curve, equation

Supply function

Qs=g(p)

Curve is upward sloping

The law of supply

ceteris peribus, the higher the price of a good, the greater the quantity supplied

Why does supply slope upward?

As production is expanded, producers have to turn to less efficient facilities and resources

Change in Quantity Supplied

Movement along the supply curve

Change in supply

Shifting of the supply curve to either the left or the right

Supply Shifters

Input prices, Price of related goods, expected future prices, number of suppliers, technology, state of nature

Change in input prices

Decrease shifts curve to the right

Prices of related goods

Substitutes: Inverse relationship

Compliments: Direct relationship

Expected future prices (supply)

A increase in expected future price will decrease supply in the short-run but will ultimately increase supply in the long-run (and vice versa).

Number of suppliers

As the number of firms producing a good increases, supply increases and vice versa.

Technology

As technology improves or increases, supply increases and vice versa.

State of nature

affects supply of crops and such

What does equilibrium mean?

Qd equals Qs.

Market Clearing Price

Equilibrium price, the market will clear and stableize

Are we usually at equilibrium?

No

How is the concept of equilibrium useful?

Helps predict direction of price changes, helps appraise performance of the economy

Price Elasticity of Demand

Measures the responsiveness of quantity demanded to a change in price, ceteris peribus.

Is price elasticity positive or negative?

always negative in computation but we ignore the sign and report it as positive (ie take absolute value). This is the only measure where the sign is ignored.

What does a larger number of elasticity mean?

it is more elastic than that of lower numbers

What does a zero elasticity mean?

It is perfectly inelastic

What type of commodities have Perfectly Inelastic Demand?

Ones that are necessary and have few close substitutes, ones that take a small part of income (eg salt).

Three things that influence Price Elasticity of Demand

Closeness of substitutes, Portion of Income spent on good, Time elapsed since price change (demand usually becomes more elastic over time)

Price elasticity of demand values between zero and one means:

Demand is inelastic

Unitary elasticity

value is one

if Elasticity of demand value is between zero and less than one it is:

Inelastic

If Elasticity of demand value is greater than one to infinity it is:

Elastic

Income elasticity of demand

Measures Responsiveness of Quantity Demanded to a Change in Income

If Income elasticity of demand is greater than one:

Good is a luxury

If income elasticity of demand is less than one:

Good is a necessity

If income elasticity of demand is negative:

Good is inferior

if Price elasticity of demand is infinity:

It is perfectly elastic

Efficient use of resources means:

Being on the PPF

Consumer surplus

There is a difference between value in use (what a consumer would be willing to pay, i.e. benefit) and value in exchange (or price).

Producer surplus

The difference between the price a producer actually gets for a commodity and the minimum price the producer would have been willing to supply the commodity for, which just follows the supply curve.

Where is producer surplus shown on a S + D graph?

THE AREA ABOVE THE SUPPLY CURVE AND UNDER THE PRICE LINE.

Deadweight loss

If a market produces less than or more than this equilibrium quantity, then some consumer and producer surplus will be lost. A loss which is no one's gain - that is a loss in total surplus area.

Factors that cause deadweight loss

Price ceilings and price floors. Taxes, subsidies, and quotas. Monopoly power

Price Ceiling

Puts an upper limit or maximum value on price. designed to hold price down

If the price ceiling is less than the efficient price than the ceiling is considered?

Effective

Non-price rationing mechanisms

When prices are held artificially below their equilibrium value, they lose their rationing function (who gets what).

Examples of Non-price rationing mechanisms

Queue rationing, Rationing by sellers preferences, coupon rationing. Usually results in a black market.

Black Market

When commodities are sold illegally at prices above the officially controlled price

Price floor

Puts a lower limit on prices or minimum value on price

Example of Price floor?

Minimum wage

Example of price ceiling?

Rent controls

Incidence of Tax on Sellers

Refers to how the burden of a tax is divided between the seller and the consumer, or who actually pays what portion of the tax.