Micro Exam 2

Review for exam 2

Highlights of chapter 4:

Definitions:

Market failure- competitive market system produces the “wrong” amounts of certain goods or services, or fails to provide any at all

Demand-side market failures- happen when demand curves do not reflect consumers' full willingness to pay for a good or service.

Supply-side market failures- occur when supply curves do not reflect the full cost of producing a good or service.

Underproduction- quantity of specific goods falls from the efficient level (equilibrium quantity) to

smaller amount of quantity. As a result, the total surplus shrinks. The society faces with

efficiency loss or deadweight loss.

Overproduction- quantity of specific good exceeds the efficient level(equilibrium quantity) to of quantity. As a result total surplus in the whole society will decline.

efficiency loss(deadweight loss)- Reductions in combined consumer and producer surplus caused by an underallocation or overallocation of resources to the production of a good or service.

Private goods characteristics- are the goods offered for sale in stores, in shops, and on the Internet.

Examples: automobiles, clothing, personal computers, household appliances, and sporting goods.

Public goods characteristics- have the opposite characteristics of private goods. Public goods are distinguished by nonrivalry and nonexcludability. Example: Highways, system of law & order

Quasi Public goods characteristics- Goods and services that could be produced and delivered in such a way that exclusion would be possible. These goods can be produced by private firms but are not that

profitable. So, the government should produce them to prevent their underproduction. Examples are education, streets, museums

free-rider problem- Once a producer has provided a public good, everyone, including nonpayers, can obtain the benefit. Everyone has an incentive to free ride.

Positive externalities (is an example of demand-side failure and creates underproduction)

negative externalities (is an example of supply-side failure and creates overproduction)

Spillover costs are called negative externalities because they are external to the participants in the transaction and reduce the utility of affected third parties (thus "negative"). Spillover benefits are called positive externalities because they are external to the participants in the transaction and increase the utility of affected third parties (thus "positive").

A tax can correct for a negative externality because taxes will increase production costs and thus product price. As the price of the product rises, the externality is reduced because less output is produced. A subsidy to producers can correct for a positive externality by increasing market supply and thus equilibrium output.

How to calculate:

Consumer Surplus(Max price willing to pay- market price), Producer surplus (market price – Min acceptable price)

Note: CS is located below the demand curve, above the equilibrium price. PS is located above the supply curve and below the equilibrium price

Highlights of chapter 6:

Definitions:

Price elasticity of demand- Measures buyers’ responsiveness to price changes

Price elasticity of supply- Measures sellers’ responsiveness to price changes

cross elasticity- Measures the responsiveness of purchases of one good to change in the price of another good

income elasticity- measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good.

Inelastic demand- Price and total revenue move in the same direction

Elastic demand- Price and total revenue move in opposite directions.

Time- primary determinant of the elasticity of supply

How to calculate:

A. Price elasticity of demand(2 formulas)

1. Ed= percentage change in quantity/ percentage change in price

2. Ed = [ change in Quantity Demanded/ (sum of Quantity Demanded/ 2) ] ÷ [change in price/ (sum of prices/ 2)]

B. Price elasticity of supply (2 formulas)

1. Es= percentage change in quantity/ percentage change in price

2. Es = [ change in Quantity Supplied/ (sum of Quantity supplied/ 2) ] ÷ [change in price/ (sum of prices/ 2)]

C. Cross Elasticity

Exy= percentage change in quantity for good x/ percentage change in price for good y

Note: sign of Exy can tell us if goods X and Y are substitute or complementary

Substitute goods if sign of Exy is positive

Complement goods if Exy is negative

Independent if Exy is 0

D. Income Elasticity

Ei= percentage change in quantity/percentage change in income

Note: sign of Ei can tell us if a good is normal or inferior

Normal goods if elasticity is positive

Inferior goods if elasticity is negative

Know: what Elastic demand, inelastic demand, unit elastic demand, perfectly elastic demand, perfectly inelastic demand, Elastic supply, inelastic supply, unit elastic supply, perfectly inelastic supply, short-run, long-run, immediate-market are, total revenue test

Highlights of chapter 7:

Definitions:

Utility- is the satisfaction one gets from consuming a good or service

total utility- the total amount of satisfaction

marginal utility- the extra satisfaction from an additional unit of the good

Law of diminishing marginal utility- As consumption of a good or service increases, the marginal utility obtained from each additional unit of a good or service decreases

Know how to calculate:

A. Marginal Utility= Change in TU/ Change in quantity

Know: Utility-maximizing rule ( consumer equilibrium)

Graphs to know:

shape of TU- Upside down U

shape of MU-straight line going down