ECON-2305 | TEST #2

Sources used: Textbook, lecture notes, homework assignment questions, rest review questions | Chapters covered: 5, 7, 8 | This set is designed as a study aid for the upcoming test on 10/10/2025. I hope it helps, and good luck—you’ve got this!

What is elasticity?

The sensitivity to a change in a variable

What are the elasticity measurements?

Price elasticity of demand, price elasticity of supply, income elasticity, and cross-price elasticity

Price increases, and demand decreases a little. When E < 1, it is…

Inelastic

Prices increase, and demand decreases just the same. When E = 1, it is…

Unitary

Price increases, and demand increases a lot. When E > 1, it is…

Elastic

What is the Mid-point formula to calculate the elasticity of demand?

E = [(Q2 - Q1) ÷ ({Q1 + Q2} ÷ 2)] ÷ [(P2 - P1) ÷ ({P1 + P2} ÷ 2)]

Why does the demand for gas tend to be inelastic in the short-run?

People always need it

What are some adjustments that could happen related to the demand for gas in the long run? 

Carpooling, new cars with better gas mileage, etc.

What are the determinants of elasticity?

Substitutes, price, income, luxuries vs. necessities, and time

It is Washington D.C. — 1980. There has been an added gas tax of 8 cents per gallon.

Price 1 = $1.52 gal

Price 2 = $1.60 gal

Quantity 1 = 16 miles / gal

Quantity 2 = 11 miles / gal

Calculate the price elasticity of demand, and round your results to the second nearest decimal

E = 7.4

What is the formula to calculate the elasticity of supply?

E = [(Q₂ − Q₁) ÷ ((Q₁ + Q₂) ÷ 2)] ÷ [(P₂ − P₁) ÷ ((P₁ + P₂) ÷ 2)]

Static tax analysis

Economic evaluation of the effects of tax rate changes under the assumption that there is no effect on the tax base, meaning that there is an unambiguous positive relationship between tax rates and tax revenues

What is a market failure?

A situation in which the market economy leads too few or too many resources going to a specific economic activity

What are some consequences of a market failure?

Prevents economic efficiency, individual freedom, and it is addressed by public policy

In some cases, the price that someone actually pays for a resource, good, or service is higher or lower than…

The opportunity cost that all society pays

Why does market failure occur?

The market system does not make individuals responsible for the social costs or benefits of their actions

What are the economic functions of government in micro failure topics?

Legal framework (institutions), maintain competition, re-distribution of income, and reallocation of resources

What are the economic functions of government in macro failure topics?

Stabilize the economy

Oakland, California, 2024:

• In-N-Out Burger — closed after 18 years. First-time to permanently close a location

• 7/11 — closed 2 stores

• Raising Cane’s — closed dining room

• Denny’s — closed after 54 years

What was the reason for all these sudden closures?

Crime

What monopoly situation is the government trying to avoid in order to maintain competition?

“Too much” market power

What systems does the government use to redistribute income?

Progressive income tax, transfer payments, and price controls

Transfer payments

Money payments made by governments to individuals for which no services or goods are rendered return

Progressive income tax

As income increases, tax rate also increases

Price controls

Government-mandated minimum or maximum prices that may be charged for goods and services

Private goods

Consumption by one person excludes consumption by another, such as food, beverages, and clothes 

Public goods

Consumption by one person does not exclude consumption by another, such as national defense, fire and police departments, parks and playgrounds, libraries, and lighthouses

Why do we need public goods?

They solve the “free rider” problem

What is the “free rider” problem?

When someone benefits but does not contribute to the payment for the benefit

Externalities

Occur when the consequences of an economic activity spill over to affect third parties

What are the two types of externalities?

Negative (spillover costs), and positive (spillover benefits)

Third parties

Parties who are not directly involved in a given activity or transaction

Property rights

Rights of an owner to use and exchange property

There is a resource misallocation where the market over-allocates, leading to an increase in external costs. This is a…

Negative externality

There is a resource misallocation where the market under-allocates, leading to “missed” external benefits. This is a…

Positive externality

How can the government correct negative externalities?

Through special taxes and regulations

Which curve do negative externalities impact, and where do they shift it?

Supply, to the left

Which curve do positive externalities impact, and where do they shift it?

Demand, to the right

When does the fiscal year take place?

Begins October 1st, ends in September 30th

How can the government correct positive externalities?

Through government financing and production, subsidies, and regulations

What are macro failures?

Unemployment, inflation, national debt, and global trade deficit through poor trade agreements

What did the Employment Act of 1946 do?

Full production, full employment, and embraced Keynesian Economics

How did Humphrey-Hawkins Act contribute in 1978?

Provided for specifics, attempt to quantify goals, proposed 4% or less unemployment, 4% or less inflation adjustable by congress

What does “institutionalized” mean?

The process of formalizing a practice, norm, or rule into established institutions such as laws, customs, or organizations that govern how economic activities are carried out

Who is in the labor force?

Non-institutionalized individuals aged 16 and older who are working or looking to work

How is the labor force calculated?

Labor Force = Number of employed individuals + number of unemployed individuals

How is the unemployment rate calculated?

Unemployment Rate = (Unemployed ÷ Labor Force) • 100

What are the 3 components observed when assessing unemployment?

Individuals who are employed, unemployed, or not in the labor force

What are the major types of unemployment?

Frictional, structural, and cyclical

Frictional unemployment

Short-term, voluntary to some degree

Structural unemployment

Likely longer-term, more persistent, and caused by economic shocks

Cyclical Unemployment

More serious, recession type of unemployment that is part of the business cycle and anticipates fiscal policy

Full employment

An arbitrary level of unemployment that corresponds to “normal” friction in the labor market

Natural unemployment

The combination of frictional and structural unemployment that exists when the economy is at full employment

What economist coined the phrase expression “Creative Destruction”?

Joseph Schumpeter

Creative Destruction

Technological inventions or advancements that replace workers

Why is it that job retraining may be challenging in structural unemployment?

Skill sets needed to complete the job are different, and human capital varies

“Gig” Economy / Workers

People who receive compensation for completing particular short-term tasks, do not have traditional long-term relationships with employers, and often do not work full time

What has increased the difficulty of counting those who are self-employed and employed part-time?

The expanding gig economy

How is the Joe Biden Administration’s rule expected to impact gig work or contracting?

It requires workers to be considered employees, not contractors

What would be the effects of Joe Biden Administration’s rule?

Labor costs will increase for business in industries that rely on contract labor or freelancers, such as trucking, manufacturing, healthcare, and app-based “gig” services

What are the productivity costs of unemployment?

Lost output, erosion of skills overtime

What are the psychological costs of unemployment?

Mental impact, stress induced illness

What are the crime costs of unemployment?

Increased crime rate, property crime, robbery and burglary

Labor Force Participation Rate

The proportion of non-institutionalized working-age individuals who are employed or seeking employment

How is the LFPR calculated?

LFPR = (Labor Force ÷ Working-Aged Population) • 100

Why has the labor force participation rate gotten so low in recent years?

Baby boomers are retiring, poor work ethic is abundant, opioid addiction, disability, and illegal immigration contributing to job competition

Why have more people aged 65+ joined the labor force after the recession of 2008?

Loss of assets, companies failed due to the recession, and their retirement plans with it

Why did more women join the workforce after the great recession?

Two household incomes were encouraged and birth control pills gave women more agency in delaying their motherhood

What was the LFPR in the 1980s?

70%

What is the LFPR today?

40%

Why did the percentage of young people working dropped between 2016 and 2019?

More attention to school without question, more competition for jobs, less interest in physical jobs, low pay and a preference to work on the academic side of the resume

Why is there a higher competition for teen jobs today?

Due to a flood of immigrant workers and older baby boomers returning to the job market

Rule of 72 formula

x • a = 72

Why not provide unemployment benefits indefinitely?

It would reduce the incentive for them to search seriously for a job, boosting the average duration of unemployment

Discouraged workers

Individuals who have stopped looking for a job because they are convinced they will not find a suitable one

How does the existence of discouraged workers bias the unemployment rate?

It makes it look better because discouraged workers are not considered to be part of the unemployment rate

What caused the spike in the unemployment rate in 2020?

The economy was unplugged

What contributed to job vacancies in COVID?

Government payments, covid shots being required to work, and school shutdowns

When was the Welfare Reform Act passed?

1996

What was the impact of the Welfare Reform Act?

Limited recipients to no more than 2 consecutive years on welfare and no more than 5 years total, required those receiving welfare to work, and gave tax breaks to any company hiring a person on welfare

Explain the rule of 72

A simplified calculation that estimates the number of years it takes for an investment to double at a fixed annual rate of return, or the rate of return needed to double an investment in a set number of years

Continuing Resolution (CR)

A temporary spending bill used to fund federal government operations when Congress fails to pass regular annual appropriations legislation on time

Inflation

A sustained increase in the average of all prices of goods and services in an economy

Price Index

The cost of today’s market basket of goods expressed as a percentage of the cost of the same market basket during a base year

How is price index computed?

Price Index = (cost of market basket today ÷ cost of market basket in base year) • 100

Base year

The year that is chosen as the point of reference for comparison of prices in other years

What are the Real-World Price Indexes?

Consumer Price Index (CPI), Producer Price Index (PPI), GDP deflator, and Personal Consumption Expenditure Index (PCE)

Consumer Price Index (CPI)

A weighted average of prices of a specified set of goods and services purchased by typical consumers in urban areas

Producer Price Index (PPI)

A statistical measure of a weighted average of prices of goods and services that firms produce and sell

GDP deflator

A price index measuring the changes in prices of all new goods and services produced in the economy

Personal Expenditure Index (PCE)

A statistical measure of average prices that uses annually updated weights based on surveys of consumer spending

How is the inflation rate calculated?

Inflation rate = [(CPI year 2 - CPI year 1) ÷ CPI year 1] • 100

How is the real dollar price adjusted for price level changes calculated?

Real dollar price = old year price • (current price index ÷ old year price index)

What are the flaws of CPI?

It does not account for the way consumers substitute less expensive items for higher-priced items, it ignores changes in consumption patterns that occur between years in which it revises the index, it does not account for quality changes as they occur, and usually ignores successful new products until long after they have been introduced

What is the difference between core inflation and headline inflation?

One does not include energy or food costs, and one is more volatile

Core CPI inflation rate

The rate of change in what remains of the consumer price index after it has been recomputed with food and energy prices removed

Nominal rate of interest

The market rate of interest observed in contracts expressed in today’s dollars

Problems caused by inflation

Price confusion due to the pricing signal being difficult to interpret, long-term planning and forecasting is very hard, it brings about uncertainty and redistributes wealth

Who is most impacted by inflation?

Fixed income folks, creditors and businesses

How are creditors impacted by inflation?

Overtime, the money paid from debtors in interest loses purchasing power