First ECON 101 Midterm 1 (Staub)

Microeconomics

the study of how households and businesses make choices

Macroeconomics

the study of how individuals, firms, and markets function together

Understand and explain the following key ideas of economics:

1. People make decisions and therefore face tradeoffs because resources are scarce

2. People are rational

3. The true cost of something includes its opportunity cost

4. "How much" decisions are made at the margin

5. People respond to incentives

Ceterus Paribus

all else equal

Positive Analysis

when analysis is based on facts and concerned with "what is"

Normative Analysis

when analysis is subjective and concerned with what "ought to be"

Efficiency

no one can be made better off without making someone else worse off

Equity

fair distribution of benefits

Why use a PPF?

to think about the trade-offs that face any economy

Points inside/on/outside the PPF are

Inside: feasible but not efficient

On: feasible and efficient in production

Outside: not feasible

Efficient in Production

economy can not produce more of any one good without producing less of something else

Efficient in Allocation

economy allocates its resources so that consumers are as well off as possible

How do you calculate opportunity cost?

OC of good X = how much good Y you could have gained in that same time / 1 unit of good X

Economic Growth shifts the PPF...

outward because the economy can produce more

A producer with a comparative advantage can...

produce more at a lower opportunity cost

A producer with an absolute advantage can...

produce more

How should you price a good in trade?

between each producer's opportunity cost of producing the good themselves

When are their gains from trade?

ALWAYS; everyone has a comparative advantage in something

Without trade you can consume...

what you produce

A producer should specialize in the good which....

they have the comparative advantage in producing.

Where does comparative advantage come from?

1. climate and natural resources

2. relative abundance of labor and capital

3. technology

What assumptions do we make about perfectly competitive markets?

many buyers and sellers

all products are identical

no barriers to entry

no individual's actions have a noticeable effect on the price sold

Law of Demand

consumers buy more of a good when its price decreases and less when its price increases

Law of Supply

producers offer more of a good as its price increases and less as its price falls

Demand vs. Quantity Demanded

Demand refers to the relationship between price and quantity while quantity demanded is how much people will buy at any given price

Supply vs. Quantity Supplied

Supply is the curve, but quantity supplied is a point on the curve.

5 factors shifting the demand curve

1. Income

2. Price of Related Goods

3. Tastes/Preferences

4. Expectations

5. Number of Consumers

How is INCOME related to shifts in the demand curve?

normal good: when income rises, demand rises

inferior good: when income rises, demand decreases

How is PRICE OF RELATED GOODS related to shifts in the demand curve?

complements in consumption: if one good increases in price, demand for its complement decreases

substitutes in consumption: if one good increases in price, demand for its substitute increases

complements in consumption

goods that tend to be consumed together

substitutes in consumption

goods that can be used in place of another good to satisfy similar needs or desires

How is TASTES/PREFERENCES related to shifts in the demand curve?

as tastes/preferences shift towards a good, increase in demand

How is NUMBER OF CONSUMERS related to shifts in the demand curve?

more people in market= more demand

less people in market = less demand

How do you calculate market demand/ market supply?

Add up all individual demands/supplys

5 factors of supply

1. Price of Inputs

2. Tech Change

3. Prices of Complements/Substitutes in Production

4. Expected Future Prices

5. Number of Sellers

How are EXPECTATIONS related to shifts in the demand curve?

expect price to increase, demand increases NOW

expect price to decrease, demand decreases NOW

How does PRICE OF INPUTS affect supply?

price of inputs increases = supply decreases

price of inputs decreases = supply increases

How does TECH CHANGE affect supply?

tech increase = supply increases

How does PRICE OF COMPLEMENTS/SUBSTITUTES affect supply?

complements in production: price of one good increases, supply of complement increases

substitutes in production: price of one good increases, supply of other decreases

complements in production

goods that must be produced together

substitutes in production

alternative products that producers COULD use their resources to make

What does it mean for a market to be at equilibrium?

quantity supplied = quantity demanded

How do you calculate market equilibrium?

1. Look at D and S schedules

2. Look at intersection on graph

3. Algebra

What if P>P*?

-Excess supply = surplus

-Driven up to equilibrium

What if P<P*

-Shortage

-Buyers will bid up the price

-Driven to equilibrium

How does increase/decrease in demand affect equilibrium?

increase: increases P* and Q*

decrease: decreases P* and Q*

How does increase/decrease in supply affect equilibrium?

increase: decrease P* and increase Q*

decrease: increase P* and decrease Q*

How does equilibrium change with simultaneous shifts in S and D?

Both increase: Q* increases, P* ambiguous

Both decrease: Q* decreases, P* ambiguous

S increase, D decrease: Q* ambiguous, P* decreases

S decrease, D increase: Q* ambiguous, P* increases

Value vs. Price

value is what we get (benefits), and price is what we pay

Consumer Surplus

the difference between what you are willing to pay and what you actually pay

CS= WTP-P

Producer Surplus

the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives

PS = P-MC

marginal cost

the cost of producing one more unit of a good

marginal benefit

the additional benefit to a consumer from consuming one more unit of a good or service

Total Surplus

consumer surplus + producer surplus

An outcome is economically efficient when...

total surplus is maximized/ marginal cost = marginal benefit

How do changing prices affect producer surplus?

price increases, increases producer surplus

price decreases, decreases producer surplus

How do changing prices affect consumer surplus?

price increases, decreases consumer surplus

price decreases, increases consumer surplus

elasticity

a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants

inelastic demand

-describes demand that is not very sensitive to price changes

-E

elastic demand

-describes demand that is very sensitive to a change in price

-E>1

-change in QD > change in P

perfectly elastic demand

-demand in which quantity drops to zero at the slightest increase in price

-E= infinity

perfectly inelastic demand

-the case where the quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero

-E= 0

unit elastic demand

-demand is unit elastic when the percentage change in quantity demanded is equal to the percentage change in price

-E= 1

How are slope and elasticity related?

-NOT EQUAL

-slope is change in P/ change in Q-- units

-elasticity is % changes --- unitless

-flatter slope = more elastic demand

formula for elasticity

formula for midpoint method of elasticity

Determinants of the Price Elasticity of Demand

1. The availability of close substitutes

2. The passage of time

3. Whether the good is a luxury or a necessity

4. The definition of the market

5. The share of a good in a consumer's budget

How does AVAILABILITY OF CLOSE SUBSTITUTES affect elasticity of demand?

more substitutes = more elastic demand

less substitutes = less elastic demand

How does PASSAGE OF TIME affect elasticity of demand?

more time = more elastic

less time= less elastic

How does LUXURIES VS. NECESSITIES affect elasticity of demand?

luxuries = more elastic

necessities = less elastic

How does DEFINITION OF THE MARKET affect elasticity of demand?

More narrow market definition = more elastic demand

Less narrow market definition = less elastic demand

How does SHARE OF A CONSUMER'S BUDGET affect elasticity of demand?

large share of good in consumers budget = more elastic

low share of good in consumers budget= less elastic

If demand is elastic, the _____ effect dominates the _____ effect, and a(n) _____ in price will cause total revenue to rise.

quantity; price; decrease

If demand is inelastic, the _____ effect dominates the _____ effect, and a(n) _____ in price will cause total revenue to rise.

price; quantity; increase

elasticity on a linear demand curve

income elasticity of demand

a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income

What is the income elasticity of INFERIOR GOODS ?

Income Elasticity of Demand < 0

What is the income elasticity of LUXURY GOODS ?

Income Elasticity of Demand > 1 ---- income elastic

What is the income elasticity of NECESSITY GOODS ?

0

cross-price elasticity of demand

a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good

What is the cross-price elasticity of SUBSTITUTES IN CONSUMPTION?

-EXY>0

- PY increases, QDX increases

- same direction

What is the cross-price elasticity of COMPLEMENTS IN CONSUMPTION?

-EXY

price elasticity of supply

a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price

Elastic Supply

EPS>1

Inelastic Supply

EPS

Perfectly elastic supply

EPS = infinity

Perfectly inelastic supply

EPS = 0

Determinants of Elasticity of Supply

1. availability of inputs

2. time

How does AVAILABILITY OF INPUTS influence elasticity of supply?

Increased availability of inputs = increased elasticity of supply

decreased availability of inputs = decreased elasticity of supply

How does TIME influence elasticity of supply?

Supply more elastic over longer time horizon

price ceilings

maximum legal price that can be charged in a market

price floors

government imposed limits on how low a price can be charged

If price ceiling is _______ P*, it will have no effect.

above

If price ceiling is _______ P*, there will be excess demand.

below

How do you calculate DWL?

TS in the efficient outcome-TS in the inefficient outcome

How do you calculate TS?

CS + PS

Dead Weight Loss (DWL)

the loss in total surplus that occurs whenever the market does not produce the efficient equilibrium quantity.

When is a price ceiling binding?

below equilibrium

Binding Price Ceilings lead to....

excess demand

Who is better off after the imposition of a price ceiling?

Consumers who can still buy the good at the lower price