Midterm II Microeconmics

What do all economic decisions involve?

The allocation of scarce resources.

What is an 'either–or' decision?

A choice about whether or not to do something.

What is a 'how much' decision?

A choice about how much of a resource to put into an activity.

What is opportunity cost?

The value of what you give up when you use a resource for a specific purpose.

What are explicit costs?

Costs that involve a direct outlay of money.

What are implicit costs?

Costs that don’t involve money but represent the value of forgone benefits.

What is economic profit?

Total revenue minus both explicit and implicit costs.

What is accounting profit?

Total revenue minus only explicit costs.

Why can accounting profit be misleading?

It ignores implicit costs like opportunity cost of time or capital.

According to the 'either–or' decision principle, how should choices be made?

Choose the activity with the positive economic profit.

What is marginal analysis?

Comparing the benefit and cost of doing one more unit of an activity.

What is marginal cost?

The additional cost of producing one more unit of a good or service.

What is marginal benefit?

The additional benefit earned from producing one more unit.

What does the marginal cost curve show?

How marginal cost changes as output increases.

What does the marginal benefit curve show?

How marginal benefit changes as output increases.

What is constant marginal cost?

When each additional unit costs the same as the previous one.

What is increasing marginal cost?

When each additional unit costs more than the previous one (upward-sloping curve).

What is decreasing marginal cost?

When each additional unit costs less than the previous one (downward-sloping curve).

What is decreasing marginal benefit?

When each additional unit provides a smaller benefit than the one before.

What is the optimal quantity?

The quantity that generates the highest total profit.

What is the profit-maximizing principle of marginal analysis?

The optimal quantity is where marginal benefit equals marginal cost.

What is a sunk cost?

A cost that has already been incurred and cannot be recovered.

Should sunk costs affect future decisions?

No — they should be ignored.

What is the sunk cost fallacy?

The mistaken belief that sunk costs should influence current decisions.

What is behavioral economics?

The study of how psychology and economics interact to explain real decision-making.

What does rational behavior mean?

Choosing the option that leads to the most preferred outcome.

Can it be rational to choose a lower economic payoff?

Yes, due to fairness, nonmonetary rewards, bounded rationality, or risk aversion.

What is bounded rationality?

When people make satisfactory decisions because finding the best one is costly or complex.

What is risk aversion?

The tendency to avoid potential losses, even at the cost of lower returns.

What is an irrational choice?

A choice that leaves someone worse off than if they had chosen another option.

Name the eight forms of irrational behavior.

1. Misperceptions of opportunity cost 2. Overconfidence 3. Unrealistic expectations 4. Mental accounting 5. Loss aversion 6. Framing bias 7. Fear of missing out (FOMO) 8. Status quo bias

What is mental accounting?

Treating dollars unequally depending on where they come from or how they’re spent.

What is loss aversion?

Oversensitivity to losses, leading to risk-avoidant decisions.

What is framing bias?

Making decisions based on how choices are presented instead of their true value.

What is FOMO (Fear of Missing Out)?

Making poor investment decisions due to fear of missing a profitable opportunity.

What is status quo bias?

Avoiding change by sticking with current choices or situations.

What are nudges in behavioral economics?

Small changes in how choices are presented to encourage more rational behavior.

What is international trade?

The exchange of goods and services between countries.

What causes international trade?

Comparative advantage — when a country can produce a good at a lower opportunity cost than another.

What are imports?

Goods and services purchased from abroad.

What are exports?

Goods and services sold abroad.

What is globalization?

The increasing economic linkages and trade between countries.

What is hyperglobalization?

Extremely high levels of international trade due to advances in technology and communication.

What does the Ricardian model of trade assume?

Constant opportunity costs and gains from trade between countries.

What does the Ricardian model show?

Two countries are better off trading than remaining in autarky.

What is autarky?

A situation where a country does not trade with others.

What determines comparative advantage in reality?

Differences in climate, factor endowments, and technology.

What does the Heckscher–Ohlin model explain?

How a country’s factor endowments determine its comparative advantage.

What does 'factor intensity' mean?

How much a good’s production uses a particular factor (like labor or capital).

According to the Heckscher–Ohlin model, what do countries export?

Goods that use their abundant factors intensively.

What determines the domestic price of a good in autarky?

The intersection of the domestic supply and demand curves.

What happens to domestic price when trade opens?

It moves toward the world price.

What happens if the world price is below the autarky price?

The country imports the good.

What are the effects of imports on surplus?

Consumer surplus rises, producer surplus falls, and total surplus increases.

What happens if the world price is above the autarky price?

The country exports the good.

What are the effects of exports on surplus?

Producer surplus rises, consumer surplus falls, and total surplus increases.

What happens to industries due to trade?

Export industries expand, and import-competing industries contract.

How does trade affect factor markets?

It raises demand for abundant factors and lowers demand for scarce ones.

What is trade protection?

Government policies that limit imports or promote exports.

What are the two main types of trade protection?

Tariffs and import quotas.

What is a tariff?

A tax on imports that raises domestic prices and reduces total surplus.

Who benefits and who is hurt by a tariff?

Domestic producers benefit; consumers are hurt.

What is an import quota?

A legal limit on the quantity of a good that can be imported.

How does an import quota differ from a tariff?

The revenue goes to those with import licenses, not the government.

What is an export subsidy?

A government payment to producers who sell goods abroad.

What is the main reason for trade protection in practice?

Political pressure from organized import-competing industries.

Why do consumers rarely oppose trade protection?

They are unaware of the hidden costs they pay.

What are international trade agreements?

Agreements between countries to reduce trade barriers and prevent trade wars.

Name some key trade agreements.

NAFTA, USMCA, European Union (EU), and World Trade Organization (WTO).

What does the WTO do?

Oversees global trade negotiations and settles disputes between member countries.

What is one major concern about globalization?

Rising income inequality, especially from manufacturing imports from poorer countries.

What is offshore outsourcing?

Moving jobs and production abroad to reduce costs.

How has globalization affected job security?

Many jobs once safe from competition have moved overseas.

What is the overall effect of trade on total surplus?

Trade increases total surplus for the economy as a whole.

What is an excise tax?

A tax on the purchase or sale of a good.

What does an excise tax do to prices?

It raises the price paid by consumers and lowers the price received by producers.

What is the tax wedge?

The difference between the price consumers pay and the price producers receive due to a tax.

What is tax incidence?

How the burden of a tax is divided between consumers and producers.

Does tax incidence depend on who officially pays the tax?

No, it depends on the elasticities of supply and demand.

When does the tax fall mainly on producers?

When the price elasticity of demand is higher than the price elasticity of supply.

When does the tax fall mainly on consumers?

When the price elasticity of supply is higher than the price elasticity of demand.

What determines tax revenue from an excise tax?

The tax rate and the number of units sold.

Why do excise taxes cause inefficiency?

They discourage mutually beneficial transactions, creating deadweight loss.

What are administrative costs of a tax?

Resources used to collect, pay, and avoid the tax, beyond the amount of the tax itself.

What happens to total surplus when a tax is imposed?

It decreases — the loss in total surplus is greater than the tax revenue collected.

What does the deadweight loss from a tax represent?

The value of transactions that no longer occur because of the tax.

When is the deadweight loss from a tax larger?

When demand or supply (or both) are more elastic.

When is there no deadweight loss from a tax?

If either demand or supply is perfectly inelastic.

What makes a tax efficient?

It minimizes deadweight loss and administrative costs.

What are the two major principles of tax fairness?

The benefits principle and the ability-to-pay principle.

What is a lump-sum tax?

A tax that is the same amount for everyone, regardless of income or behavior.

Why is a lump-sum tax efficient but unfair?

It doesn’t distort incentives but ignores differences in ability to pay.

What trade-off exists in tax policy?

A trade-off between equity (fairness) and efficiency.

What is a tax base?

What is being taxed (e.g., income, sales, property).

What is a tax structure?

How the tax depends on the tax base — such as being proportional, progressive, or regressive.

Give examples of different tax bases.

Income tax, payroll tax, sales tax, profits tax, property tax, and wealth tax.

What is a proportional tax?

A tax that takes the same percentage of the base for all taxpayers.

What is a progressive tax?

A tax where higher-income people pay a higher percentage of their income.

What is a regressive tax?

A tax where lower-income people pay a higher percentage of their income than higher-income people.

Which fairness principle justifies progressive taxes?

The ability-to-pay principle.