ECON 101 Exam 1 (UMICH - Wolfers)

what affects your decision via the interdependence principle? (4)

your other decisions, (you have limited resources, other constraints) decisions made by others within the market, decisions made by others in other markets, expectations over time

What drives all economic forces?

individual decisions

Name the four core principles of economics

cost benefit, opportunity cost, marginal, interdependence

Buy when costs (<,>,=) benefits

<

How would you compare decisions that have nothing in common?

willingness to pay

economic surplus

benefits - costs from a decision, measures how much the decision improved your well-being

framing effect

differences in the way decisions are described can lead people to make different (illogical) decisions

opportunity cost

the true cost of something is the next best alternative you must give up to get it (included in costs when calculating costs vs benefits)

scarcity

resources are limited, so any use of them comes at an opportunity cost

steps to evaluating opportunity cost

what happens if you pick your choice? what happens if you pick the next best alternative?

sunk costs

time/effort/etc. put into the project which cannot be reversed (IGNORED in costs vs benefits and exists regardless of which choice is made)

possibility production frontier

shows different outputs attainable with a set of scarce resources, describes the most you can produce given the circumstances (more of A means less of B, etc.)

how to shift out the PPF (shift right)

new production techniques

marginal principle

decisions about quantities are best made incrementally (break down into smaller questions to ask "one more?" instead of "how many?")

you should apply the marginal principle and ask "one more?" until:

marginal benefits >= marginal costs (when your economic surplus is maximized)

interdependence principle

the best choice depends on other choices and outside factors

someone else's shoes technique

think about others' objectives and constraints to predict their decisions

total marketwide demand

sum of individual demand choices made by buyers

individual demand curve

graph plotting the quantity of an item someone intends to buy at various prices (P vs Qd) (summarizes BUYING PLANS and how they vary with price)

Price is graphed on the ___ axis, and Quantity is on the ___ axis

y, x

the demand curve is always ___ - sloping

downward (as P increases, Q decreases)

Demand and supply curves are graphed holding ___ ___ ___. This is an example of the ___ principle because the curve is applicable only under the conditions which it was created.

other things constant, (ONLY price changes along the curve) interdependence

law of demand

individual demand curves are downward sloping; as price increases, quantity decreases

rational rule for buyers

buy more if the marginal benefit >= the price

how many? --> (___ principle) one more? --> (___ principle) marginal benefit >= price? --> (___ principle) marginal benefit of this decision vs that of next best alternative? --> (___ rule) buy?

marginal, cost benefit, opportunity cost, rational

the demand curve is the same as the ___ curve

marginal benefits

diminishing marginal benefits

each additional item yields a smaller marginal benefit than the previous item

demand curves are downward sloping because ___

diminishing marginal benefit

market demand curve

plots total quantity of item demanded by the whole market at each price

market demand

sum of quantity demanded by each person

steps to find total market demand (4)

1. survey customers asking how much they would each buy at each price (know your sample size!) 2. take sum of total quantity demanded at each price individually 3. scale up quantities demanded to be representative of the whole market 4. make the graph

scaling factor (when taking a total market demand/supply sample and scaling up to be representative of the total population)

(size of market)/(size of survey)

market demand and individual demand curves are both ___ sloping because ___

downward, the market demand curve is made up of individual demand curves

what are the two aspects of demand to consider?

changing demand among existing customers, extra demand from new customers (this is why you must also survey potential customers, not just ones you already have)

A change in price causes a ____, yielding a change in ___ (the answer is regarding demand, but this also applies for supply curves)

movement along the demand curve, quantity demanded

when the curve shifts ___, there is an increase in demand/supply, and when the curve shifts ___, there is a decrease in demand/supply at every price (whichever one your graph is depicting)

right, left

factors that shift the demand curve (6) (PEPTIC)

prices of related goods, expectations, preferences, type/number of buyers, income, congestion/network effects

an increase in income means a ___ in demand for normal goods, and a ___ in demand for inferior goods

increase, decrease

complementary goods

goods that go well together; if you buy more of one, you buy more of the other

substitute goods

goods that can replace each other; if you buy more of one, you buy less of the other

network effect

good becomes more valuable when more people use it

congestion effect

good becomes less valuable when more people use it

unlike the other 5 factors, type and number of buyers only affects the ___ demand curve

market (NOT individual)

individual supply curve

graph of quantity supplied at each price (holds everything but price constant)

law of supply

as price increases, the quantity supplied increases (supply curves are upward sloping)

why is the supply curve upward sloping?

rising marginal cost/diminishing marginal product (some inputs are fixed, marginal product declines as you use more of it, and extra output from each worker hired is not as large as that of the previous one)

perfect competition

everyone in the market sells an identical good and there are many buyers and sellers who are small relative to the market (everything we are looking at so far takes place in a perfectly competitive market)

price takers

firms who follow the market price and do not affect the prevailing market price (perfect competition)

why are firms in perfect competition markets price takers?

they cannot raise the price without losing customers, and reducing the price only reduces profits because the firm is small relative to the market

what is the only things suppliers have to worry about in a perfect competition market?

the quantity to supply at any given price (they do not set the price!)

variable costs

vary with output (ex: labor, raw materials)

fixed costs

do not vary with output (irrelevant to opportunity cost, ex: equipment, buildings, land)

rational rule for sellers

supply one more if price >= marginal cost (maximizes profits)

the supply curve is the same thing as a ___ curve

marginal cost

marginal product

increase in output from an additional unit of input

diminishing marginal product

extra output from each worker hired is not as large as that of the previous one

market supply

total quantity of an item across all firms in the market (add up all individual supply curves)

where does the data come from to create market supply curves?

business surveys of firms AND potential firms

list the factors that shift the supply curve (5)

Input prices, Productivity/technology, Prices of related outputs, Expectations, Type+number of sellers

substitutes in production

goods that use the same resources and making more of one means making less of the other (as supply of A increases, supply of B decreases)

complements in production

goods that are by products of each other and making more of one means making more of the other (as supply of A increases, so does supply of B)

market economy

markets organize what is produced, how they are produced, and who gets them; individuals make production/consumption decisions (US, Australia, Canada)

planned economy

centralized decisions made about what is produced, how they are produced, and who gets them; governments make production/consumption decisions (former Soviet Union, China (kind of))

market

setting that brings buyers and sellers together

equilibrium

point of no tendency to change; quantity demanded and supplied are equal; there is a buyer for every seller and vice versa (graphically found at the intersection of the market supply+demand curves)

___ pushes markets towards ___

competition, equilibrium

shortage

Quantity demanded > Quantity supplied (sellers must raise price)

surplus

Quantity supplied > Quantity demanded (sellers must lower price)

What are the symptoms of a market in disequilibrium? (3)

queuing, bundling of extras, secondary market

queuing

waiting in line for goods (raises price via time)

secondary markets raise the ___ without raising the price charged by sellers

effective price

If demand increases, it shifts ___ which causes the equilibrium price to ___ and the equilibrium quantity to ___ (assuming the supply is constant)

right, increase, increase

If demand decreases, it shifts ___, which causes the equilibrium price to ___ and the equilibrium quantity to ___ (assuming the supply is constant)

left, decrease, decrease

If supply increases, it shifts ___, which causes the equilibrium price to ___ and the equilibrium quantity to ___ (assuming the demand is constant)

right, decrease, increase

If supply decreases, it shifts ___, which causes the equilibrium price to ___ and the equilibrium quantity to ___ (assuming the demand is constant)

left, increase, decrease

When demand shifts, P and Q move in the ___ direction, and when supply shifts, P and Q move in the ___ direction

same, opposite

Steps of predicting equilibrium shifts (3)

1. Is it supply or demand that shifts? 2. Does it shift left or right? 3. How do P and Q change?

When both S and D shift, find equilibrium by adding up the effects. however, if it contradicts, you look at which curve has ___

the biggest impact (which curve shifts the most)

if P and Q moved in the same direction during an equilibrium shift, then ___ definitely shifted (and it is possible that ___ did also)

demand, supply

if P and Q moved in the opposite directions during an equilibrium shift, then ___ definitely shifted (and it is possible that ___ did also)

supply, demand

elasticity of demand (and equation)

measures how responsive buyers are to price changes (E = (%change Qd)/(%change P)) (can be positive or negative, but when comparing, use their magnitude/absolute value)

if something is elastic, its elasticity is (/=) 1, and the curve will be (flat/steep)

>, flat

if something is inelastic, its elasticity is (/=) 1, and the curve will be (flat/steep)

<, steep

unit elastic

elasticity is equal to 1

perfectly elastic

at any price, the quantity is infinite and the curve is horizontal (can be for supply or demand)

perfectly inelastic

at any price, the quantity is always the same and there is no change, the curve is vertical (can be for supply or demand)

what determines elasticity of demand?

availability of substitutes (amount of competing products, specific brand vs category, necessity vs luxury, consumer search, time)

midpoint formula (used to calculate Q or P for elasticity)

(Q-Qo)/((Q+Qo)/2) * 100 (i used Q here, but you can do this for P also. Q is the final, Qo is the initial)

total revenue

price * quantity, area of the rectangle under the demand curve formed by drawing lines from P and Q to the point on the graph

when prices are elastic, you should (raise/not raise) the price, but when prices are inelastic, you should (raise/not raise) the price.

not raise, raise

cross price elasticity of demand (and equation)

measures how responsive the demand of one good is to price changes in another good ((%change Qd of x)/(%change P of y))

a positive cross price elasticity means that consumers buy (more/less) of x when the price of y increases, so they are (substitutes/complements)

more, substitutes

a negative cross price elasticity means that consumers buy (more/less) of x when the price of y increases, so they are (substitutes/complements)

less, complements

the magnitude of the cross price elasticity shows...

how close substitutes/complements x and y are (0 is independent, higher numbers are closer)

income elasticity of demand (and equation)

measures how responsive a good is to changes in income ((%change Qd)/(%change Income))

income elasticity is (+/-) for normal goods, and (+/-) for inferior goods. it is (larger/smaller) for necessities and (larger/smaller) for luxuries.

+, -, smaller, larger

when demand is elastic, it is because buyers ____. when supply is elastic, it is because sellers ____.

have easily changing demand, can easily change production

what determines elasticity of supply?

flexibility of production (inventories, variable/available inputs, extra capacity, easy entry/exit to market, time)

taxes (increase/decrease) Qd and Qs

decrease (buyers pay more, sellers get less)

statutory burden

who is assigned by the government to send the tax payment (either buyer or seller) (does not matter, as the effects are the same either way)