ECON 251-H Midterm 1 Study Guide

YARBROUGH CHAPTERS

Chapter 1

  • Economics concerns itself with understanding how people, firms, governments, and economic systems react to changes.

  • What does microeconomics do?

    • analyze economic choices and outcomes at the sub-national, firm, and/or individual levels

  • What are some subfields of microeconomics?

    • public finance

    • environmental economics

    • health economics

    • industrial organization

    • game theory

  • Positive vs. Normative

    • Positive: what is

    • Normative: what should be

  • What is the most famous economic model?

    • The Supply and Demand Framework

  • What is an example of a counterintuitive outcome and explain this outcome?

    • Jevon’s Paradox - William Jevons saw that once more coal-efficient coal burning systems were in place, more coal would be burnt as coal now had more economic value

  • What are 3 basic concepts of economics?

    • Incentives - stimuli that encourage behavior

    • Scarcity - limited available amount of something affects its economic behavior

    • Opportunity Cost and Tradeoffs - consumption and production of something tends to preclude such behavior for something else

  • Classical Economics

    • Industrial Revolution

    • Adam Smith - Wealth of Nations

      • Invisible Hand Theory - central basis of capitalism - ability of economic markets to adequately and efficiently produce economic and social prosperity with limited governmental intervention

    • Jeremy Bentham - founded utilitarianism

      • promoted the idea that happiness and pain are the guiding principles of human behavior

    • What increased specialization and encouraged countries to trade with one another?

      • Trade Liberalization

    • Who wrote the theory of comparative advantage?

      • John Stuart Mill

    • What did Say’s Law say?

      • production of goods created the demand for even more goods

    • What is a model of classical economics?

      • circular flow diagram

    • What was the birthplace of modern microeconomics?

      • marginal revolution

    • What does thinking on the margin mean?

      • economic decisions as a set of incremental choices consumers and producers must make

    • Law of Diminishing Marginal Returns

      • utility diminishes as more and more of a good is consumed

    • What are the assumptions of the neo-classical paradigm?

      • Humans are rationally self-interested and have full information

      • Consumers pursue utility maximization, while producers pursue profit maximization

    • Demand curve represents the pursuit of utility maximization by consumers

    • Supply curve represents the pursuit of profit maximization by producers

    • At the point, equilibrium exists meaning all units of the product are sold at equilibrium price - which is efficient

    • During marginal revolution, social welfare began to be something that was cared about

      • Pareto Frontier

        • represents all points that would be considered pareto efficient

    • Fundamental Welfare Theorems of Economics - if the neo classical assumptions hold and there are no externalities and no information

      • Competitive economic markets are pareto efficient

      • A Pareto efficient outcome can be achieved with redistribution of initial endowments

    • Externalities are a type of market failure where there exists costs or benefits to third parties that are not involved in an economic transaction

    • What is the Pigouvian Tax?

      • a charge placed on a good that produces an externality relative to the damage caused by that externality

    • What is an example of a positive externality?

      • Education - benefits private consumer and public

    • What does sustainability mean?

      • the perpetual maintaining of some system

    • What is loss aversion theory?

      • people feel the pain of a loss more intensely than the pleasure of an equivalent gain

    • What is game theory?

      • individuals are working as a group for a common goal, rational-self interest may lead them to make sub-optimal decisions

    • What constrains choice?

      • income, costs, location, and even preferences

    • What are Yarbrough’s Laws of Humans?

      • Humans behave according to rational self-interest

      • Humans will avoid risk unless doing so would conflict with the First Law

      • Humans can be compensated to take on risk unless doing so would conflict with the First or Second Laws

    • What does ceteris paribus mean?

      • holding all other factors constant

    • Economic Assertions:

      • Humans respond to incentives, but not always intuitively

      • Humans try to optimize by thinking on the margin, but do not always have full information

      • Choices always have trade-offs and opportunity costs, which humans ignore at their own peril

      • Markets arise out of self-interest and mutual benefits, but prosperity is unevenly distributed

      • Good systems align self-interest with the social-interest, and markets have that potential

      • Sometimes markets fail, so intervention can improve efficiency

Chapter 2

  • Microeconomics asks what questions?

    • How do humans make decisions?

    • What are the outcomes of these decisions for themselves and society?

  • Heuristics: the framework of assumptions that humans use when deciding how to behave

  • What is time value?

    • the fact that $100 today does not equal $100 tomorrow

  • What is absolute advantage?

    • the ability of an entity to produce a product quicker and in greater quantities than other entities

  • What is comparative advantage?

    • the ability of an entity to produce a product with lower opportunity cost than other entities

  • What graph shows both absolute and comparative advantages?

Production Possibilities Frontier (PPF)

  • What is the first equimarginal principle?

    • marginal net benefits are maximized when marginal costs equals marginal benefits

  • What is sunk cost fallacy?

    • idea that humans are distracted by resources that have already been expended, allowing this to influence decisions in ways it should not

  • What is status quo bias?

    • humans are inclined to continue behaviors they are currently engaging in even if those behaviors are not having their intended effects

  • What is framing?

    • how the options are framed, affects the perceptions of their respective outcomes despite the outcomes being equivalent

  • What is the gambler’s fallacy?

    • a situation where someone believes they see a pattern that they believe will end

  • What is the hot-hand fallacy?

    • assumption that the current pattern will continue to occur

Chapter 9

  • What is a duopoly?

    • a market with exactly two firms 

  • What are the four characteristics of all games? 

    • Players 

    • Timing 

    • Payoffs 

    • Information 

Chapter 3

  • What is the Utilitarian Social Welfare Function? 

    • goal is to maximize the happiness of society, where everyone is self-interested 

  • What is the Social Utilitarian Social Welfare Function? 

    • goal is to maximize the happiness of society, where everyone cares about their own happiness and the happiness of others 

  • What is the Rawlsian Social Welfare Function? 

    • goal is to maximize the happiness of the least happy person 

  • What is the social contract? 

    • democratic agreement between society and its government on the social welfare function that will be used to set policies 

  • Slope of the budget constraint? 

    • ratio of prices for the two goods

VARIAN CHAPTERS

Chapter 1

  • Economic proceeds by making models of social phenomena, which are simplified representations of reality

  • Economists are guided by the optimization principle, which states that people typically try to pick what is best for them

  • Economists are also guided by the equilibrium principle, which says prices will adjust until demand and supply are equal

  • The demand curve measures how much people wish to demand at each price

  • The supply curve measures how much people wish to supply at each price

  • Equilibrium price = demand = supply

  • What is the study of equilibrium price and quantity change when underlying conditions change called?

    • comparative statics

  • An economic situation is Pareto efficient if there is no way to make some group of people better off without making another group worse off

Chapter 2

  • The budget set consists of all bundles of goods that the consumer can afford at given price and income

  • Increasing income shifts the budget line outward

  • Increasing the price of good 1 makes the budget line steeper

  • Increasing the price of good 2 makes the budget line flatter

  • Taxes, subsidies, and rationing change the slope and position of the budget line by changing the prices paid by the consumer

Chapter 3

  • Economists assume that a consumer can rank various consumption possibilities. The way this is ranked shows the consumer’s preferences

  • Indifference curves can be used to show different kinds of preferences

  • Well-behaved preferences are monotonic (more is better) and convex (averages preferred to extremes)

  • The marginal rate of substitution (MRS) measures the slope of the indifference curve. This is how much a consumer is willing to give up of good 2 for good 1.

Chapter 4

  • A utility function is simply a way to represent or summarize a preference ordering. The numerical magnitudes have no actual meaning.

  • If a utility function is transformed monotonically, its preferences will be the same

FREAKNONOMICS

Chapter 1

  • Economics is the study of incentives and how people get what they want or need when other people want or need the same thing.

  • Any incentive is inherently a trade-off, but the trick is to balance the extremes

  • Most incentives don’t come organically, and instead are social, economic, or moral.

    • Ex: Cigarettes

      • Economic: higher taxes on cigarettes

      • Social: banning smoking indoors

      • Moral: government asserting that terrorist funding groups sell black-market cigarettes

QUIZZES

Quiz 1

  • Suppose the Marginal Benefit of working out is MB = 100 - 2H, while the Marginal Cost of working out is MC = 20 + 4H. What is the optimal hours spent working out per week?

    • 13.333

  • Comparative Advantages drive what important economic concept?

    • specialization

  • According to Yarbrough (2020), what is required for the First Fundamental Welfare Theorem to holdup?

    • Neo-classical Assumptions + no externalities + no information problems

  • According to Yarbrough (2020) chapter 1, the era that saw the establishment of microeconomics was referred to as what?

    • the marginal revolution

  • Yarbrough (2020) chapter 1 asserts that Economics is the study of [�], while Microeconomics is the study of [�]

    • change; choice

  • Chapter 1 of Freakonomics includes discussion regarding incentives for all of the below expect one, which is it?

    • economic professors

  • Of the classic economic theories discussed so far, which one do economists largely reject today?

    • Say’s Law

  • What role did our Guest Speaker this week have at Dell Computers?

    • CFO of retail sales

  • According to the "Yarbrough Rules of Humans" as laid out in chapter 1 of Yarbrough (2020), what can cause humans to accept some risk?

    • compensation

  • As discussed with the guest speaker, delegating tasks requires delegators to understand what?

    • incentive compatibility

  • According to Yarbrough (2020) chapter 2, every single choice a human makes involves some sort of [�].

    • Cost-benefit Analysis

  • Economists use [�] to help make their models/theories easier to understand.

    • assumptions

  • If Ben can either knit 2 scarves or sew 4 dresses in 8 hours; while Melanie can either knit 2 scarves or sew 3 dresses in 8 hours. Who has the comparative advantage in knitting scarves?

    • Melanie

  • Economists are often interested in outcomes in which the behavioral responses to some incentive is not predicted. We refer to these events as?

    • counterintuitive

Quiz 2

Formulas

Utility = u\left(x,y\right)

Marginal Utility of x = \frac{\Delta U}{\Delta x}

Cost-Benefit AnalysisB>C

Cost-Benefit Analysis \frac{B}{C}>1

Net Present Value (NPV) \frac{b-c}{\left(1+i\right)^{t}}

Net Future Value (NFV) \left(b-c\right)\cdot\left(1+i\right)^{t}

b = benefits, c=costs, i=discount rate, t=time period

TC=EC + IC

TC=total cost, EC=explicit cost, IC=implicit cost

Marginal Costs = \frac{\Delta TC}{\Delta Q}

Marginal Benefits = \frac{\Delta TB}{\Delta Q}

TC=Q^2

TB=100Q-Q^2

MC=2Q

MB=100-2Q

Utilitarian SWF: max[Hsociety]= h1+h2+hN….. 

Social Utilitarian SWF: max[Hsociety]= H1(h1,h1) + H2(h2h2) +…… 

Rawlsian SWF: max[Hsociety]=min{h1,h2,….}

Marginal Utility: 

    MU_{x}=\frac{\Delta u}{\Delta x};MU_{y}=\frac{\Delta u}{\Delta y}

Budget Line:

p_1x_1+p_2x_2=m

Marginal Rate of Substitution:

MRS = \frac{\Delta X_2}{\Delta X_1}=\frac{-MU_1}{MU_2}

Quantity Demand: Q^{D}=a+bP