Econ 101 Exam - Steve Trost UW - Madison

cost-benefit principle

evaluate full sets of costs and benefits of any choice --> only pursue if costs are lest than or equal to the benefits

Framing

how a situation is presented to us

opportunity cost principle

The true cost of something is the next best alternative you must give up to get it

Marginal Principle

decisions about quantities best made incrementally (what the extra cost or benefit is in changing one unit)

sunk costs

a cost that has been incurred that cannot be reversed or avoided

Interdependence Principle

best choice depends on the other choices you make, the choices others make, developments in other markets, and expectations about the future; outside factors affect your choices

Positive

refers to statements based on facts and objective analysis of observable data

normative

refers to statements based on subjective opinions and value judgements about what "should be" in an economic situation

Economic mistakes of decision making

mistakes of ignoring secondary effects or not thinking about unintended consequences, association does not imply causation, the fallacy of composition, be aware of "self-selection"

Demand

a relationship between the price of a good and the quantity of that good that consumers are willing and able to buy per period, other things constant (line or curve)

Quantity Demanded

the amount (number of units) of a product that a consumer would buy in a given period if it could buy all it wanted at the current market price

law of demand

price and quantity are inversely related, as price goes up, quantity people want to buy falls (all else equal)

substitution effect

as the price of one good rises, people switch from buying that good to buying other goods

Income effect (broader)

as the price of anything goes up, you feel poorer so you buy less of everything (including good whose price rose)

Rational Rule for Buyers

buy more of an item if its marginal benefit is greater than or equal to the price

law of diminishing marginal utility

as you consume more of one thing, holding all else constant, your additional benefit (or utility) decreases until it gets less and less

Demand shifters

income, tastes and preferences, prices of related goods, expectations, congestion and network effect, type and number of buyers

Network effect

the effect that occurs when a good becomes more useful because other people use it

congestion effect

the effect that occurs when a good becomes less valuable because other ppl use it

supply curve shifters

change in input price, change in tech/production growth, change in price of other goods (substitutes or complements), change in producer expectations, change in number of producers

supply

relationship between the price of a good and the quantity of that good that firms are willing and able to sell per period, other things constant

quantity supplied

the amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period

law of supply

the positive relationship btw price and quantity of a good supplied: increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied (ceteris paribus)

total revenue

the total amount of revenue obtained from selling Q units of something TR = P*Q

marginal revenue

the additional revenue gained by the sale of one more unit of something; lies below demand curve and declines faster

rational rule for sellers in perfectly competitive markets

sell one more item if the price is greater than (or equal to) the marginal cost

marginal product

the additional output that can be produced by adding one more unit of a specific input

increase in supply

a shift of the supply curve to the right

decrease in supply

a shift of the supply curve to the left

market

any setting that brings together potential buyers

equilibrium

the condition that exists when quantity supplied and quantity demanded are equal, no tendency for price to change at this point

shortage

quantity demanded exceeds quantity supplied at the current price, market not in equilibrium and must rise

surplus

quantity supplied exceeds quantity demanded, market not in equilibrium and prices must fall

elasticity

a general concept used to quantify the response in one variable when another variable changes

elastic demand

quantity responds more than the percent change in price, elasticity is less than one, quantity is VERY responsive to changes in price, flat

inelastic demand

quantity doesn't respond much based on price, steep, elasticity is greater than one

perfectly elastic demand

demand for which quantity drops to zero at the slightest increase in price, infinitely responsive demand, completely flat demand curve

unitary elasticity

demand for which the percentage change in quantity of a product demanded is the same as the percentage change in price in absolute value (ED = 1), sort of responsive to demand

perfectly inelastic demand

demand for which quantity demanded does not respond at all to a change in price (ED=0), vertical demand curve

price elasticity equation

absolute value of (% change in quantity demanded / % change in price)

elasticity factors

availability of substitutes, necessities have less elastic demand, availability to search for substitutes, demand (usually) gets more elastic over time, low price and infrequent purchase lead to lower elasticity

price increase and elasticity

increasing price and lowering Qd always increases TR on inelastic demand, questionable choice on elastic demand

price cut and elasticity

decreasing price on inelastic demand always lowers TR, questionable on elastic demand

cross-price elasticity of demand

measures how sensitive quantity demanded is to price changes of other goods

income elasticity of demand

measures how sensitive quantity demanded is to changes in income

cross-price elasticity of demand mathematically

% change in Qd/% change in price of another good --> positive means goods are substitutes, negative means goods are complements

income elasticity of demand mathematically

% change in Qd/% change in income --> positive for normal goods, negative for inferior goods

price elasticity of supply

measures how responsive sellers are to price changes; % change Qs/% change P; calculate using midpoint formula

determinants of price elasticity of supply

larger when: firms store inventories, inputs are easily available, firms have extra capacity, firms can easily enter and exit the market, there's more time to adjust

marginal product of labor

extra production that occurs from hiring an extra worker

marginal revenue product

measures the marginal revenue from hiring an extra worker (MRP = MP*Price), the demand curve

Rational Rule for Employers

hire more workers if the marginal revenue is greater than (or equal to) the wage (MRP = MB of employers), maximizes profits in input markets

Labor demand shifts

derived demands, scale effect, substitution effect, better management and productivity gains, non-wage benefits and taxes

derived demands

occurs bc the demand for labor is derived from the demand for the stuff labor makes

scale effect

output effect, when the price of capital declines, you can produce output more cheaply, so you need more workers to produce more things

substitution effect (demand shifts)

if you can replace labor with capital, your need for workers will fall

leisure

anything you do that you don't get paid for

rational rule for workers

work one more hour as long as the wage is at least as large as the marginal benefit of one more hour of leisure

substitution effect (supply of labor)

higher wages make work relatively more attractive

the income effect (supply of labor)

higher income makes leisure more attractive

labor supply shifters

wage, other uses of time, other sources of income, need for more money, need for more "leisure", perks of job, experiences

Market Labor Supply Shifters

changing wages in other occupations, changing number of potential workers, changing benefits of not working, nonage benefits, subsidies, and income taxes

tax on sellers

supply curve shifts left/up by the amount of the tax, treated as an additional cost, leads to decline in quantity sold, increases price buyers pay and decreases price sellers receive (share economic burden)

tax on buyers

curve shifts left/down by the amount of the tax, decline in quantity sold, increase what buyers pay and decrease what sellers receive, both parties share economic burden

taxes mathematically

subtract tax from Ps

tax incidence

the division of the economic burden of a tax between buyers and sellers

tax burden and elasticity

whoever (supply or demand) has a less elastic (steeper) curve pays more of the tax

do determine who pays more of the tax

find Q with tax and plug it into original S and D equations

subsidy

payment made by gov to encourage ppl to act a certain way (acts like taxes in many ways but is beneficial to buyers and sellers (shifts both to the right, demand up, supply down)

price ceiling

a max price that sellers can charge, when set below eq price creates shortage

unintended consequences of a price ceiling

long lines or time wasted on searching for goods, black markets, add-on, discrimination by the seller, low quality products

price floor

a minimum price that sellers can charge, when set above eq price creates surplus

solving for price floor or ceiling

plug in binding price control, solve for Qs and Qd, can see shortage/surplus

mandate

a requirement to sell a minimum amount of a good (not very common)

quota

a limit on the max quantity of a good that can be sold

math for quantity regulations

use inverse D, plug in binding quantity control for Qs and Qd, Dif "prices" (Ps = marg cost to society, D = marg benefit to society)

economic surplus

total benefits minus total costs flowing from a decision

economic efficiency

the more economic surplus generated, the more efficient the outcome

efficient outcome

yields largest possible economic surplus

equity

ignored by efficiency, fairer distribution of economic benefits

Pareto efficient

a situation such that no on can be made better off without making someone else worse off

Pareto improvement

when a change can make at least one person better off without making anyone else worse off

rational rule for market

produce until marginal benefit = marginal cost

consumer surplus

the differences btw max amount a person is willing to pay for a good and its current market price: the surplus someone has from buying something

producer surplus

the difference btw current market price and the marg cost of production for the firm: Econ surplus from selling something

market failure

occurs when forces of supply and demand lead to an inefficient outcome

sources of market failure

market power, externalities, info problems, irrationality, government regulations

deadweight loss

how far economic surplus falls below the efficient outcome; efficient Econ surplus minus actual Econ surplus

gains from trade

benefits from reallocating resources, goods, and services to better use

absolute advantage

to be "absolutely" better at something

comparative advantage

to be "comparatively" better at something

moral of specialization

if we all specialize in what we are good at then as a group we can produce more stuff

division of labor

when each person specializes in one small part of the production process

Law of Comparative Advantage

the country that has the lowest opportunity cost of producing a good should specialize in the production of that good

terms of trade

the ration at which a country can trade domestic products for imported products; how much one good can be exchanged for one unit of another good

moral to trade

by specializing in a good for which there is a comparative advantage and trading some, a country can expand its possible consumption

theory of comparative advantage

theory that specialization and free trade will benefit all trading partners. real wages (what people will buy with their money) will rise

trade costs

extra costs incurred as a result of buying or selling internationally rather than domestically

economies of scale/mass production (comp adv)

when economies of scale are present, such that per-unit cost is decreasing with output, then countries can lower costs through increasing the size of firms and industries

exchange rate

the ratio at which two currencies are traded