Hadley Millerman - Micro econ 1 exam study guide 2

MICRO-Economics Unit I Exam – The Nature and Functions of Product Markets

Chapters- Modules 46-51

Key Terms

• Elasticity of Demand: Measure of responsiveness of quantity demanded to a change in price.

  • Determinants of Elasticity of Demand: Includes availability of substitutes, necessity vs luxury, proportion of income, time period, etc.

• Elasticity of Supply: Measure of responsiveness of quantity supplied to change in price.

  • Determinants of Elasticity of Supply: Factors influencing producer's ability to produce, availability of resources, time frame, etc.

• Income Elasticity: Measures how the quantity demanded changes as consumer income changes. Formula: % Change in Quantity Demanded / % Change in Income.

• Cross Price Elasticity: Measures responsiveness of demand for one good when the price of another good changes. Formula: % Change in Quantity Demanded of Good A / % Change in Price of Good B.

• Consumer Surplus: Difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: Difference between what producers are willing to accept and what they actually receive.

• Marginal Benefit / Marginal Cost: The additional benefit received from consuming one more unit versus the additional cost incurred.

• Utility Maximization Rule: Consumers maximize utility where Marginal Benefit (MB) equals Marginal Cost (MC).

Elasticity Changes on Demand Curve

• Elasticity can change along the demand curve depending on the price and quantity.

Taxation Concepts

• Tax Incidence: Analysis of who bears the burden of a tax.

• Types of Taxes:

  • Progressive: Higher percentage on higher incomes (e.g., income tax).

  • Regressive: Higher percentage on lower incomes (e.g., sales tax).

  • Proportional: Same percentage regardless of income (e.g., flat tax).

Elasticity and Tax Burden

• The relationship between elasticity of demand/supply and tax burden; more inelastic goods bear a higher tax burden.

Graphical Representations

• Perfectly Elastic Supply/Demand: Horizontal line (graph showing extreme sensitivity to price).

• Perfectly Inelastic Supply/Demand: Vertical line (graph showing no sensitivity to price).

• Unit Elastic: 45-degree line indicating proportional responsiveness.

• Normal vs Inferior Goods: Normal goods have positive income elasticity; inferior goods have negative income elasticity.

Price Controls

• Price Floors: Minimum allowable price (e.g., minimum wage).

• Price Ceilings: Maximum allowable price (e.g., rent control).

Market Efficiency

• Economic efficiency occurs when resources are allocated optimally.

• Substitutes and Complements:

  • Substitutes increase demand if the price of one goes up.

  • Complements decrease demand if the price of one increases.

Elasticity Calculations and Applications

1. If Anna wants to increase total revenue at $10/pound with an elasticity of demand of 2.5:

   • Advice: Lower price to increase quantity sold, thereby increasing total revenue.

2. If cross elasticity between peanut butter and milk is -1.11:

   • Conclusion: They are complements (demand for one decreases as the price of the other increases).

3. For a good with a 10% income increase leading to a 15% demand decrease:

   • Income Elasticity: -1.5 (inferior good as indicated by negative sign).

4. Price increase of 8% leading to a 12% drop in quantity demanded:

   • Price Elasticity: -1.5 (indicates elastic demand).

Total Revenue Test

• Total Revenue increases when price is lowered for elastic demand.

• Use graphs to illustrate elasticity effects on total revenue:

  • Show Total Surplus, Consumer Surplus, Producer Surplus, Tax Wedge, and Tax Revenue box.

Explanation of Concepts

Cross Price Elasticity

• Definition: Measures the efficiency of two related goods.

  • Positive Coefficient: Goods are substitutes.

  • Negative Coefficient: Goods are complements.

  • Example: Butter and margarine as substitutes; gas and public transport as complements.

Income Elasticity

• Definition: Measures how demand responds to income changes.

  • Positive Coefficient: Normal goods (e.g., organic food).

  • Negative Coefficient: Inferior goods (e.g., generic brands).

Business Applications of Elasticity

• Businesses use elasticity to determine pricing strategies during promotions to maximize sales; for example, lowering prices on luxury items may attract more customers.

Application of Elasticity in Programs

• UN Slave Redemption Program: Elasticity theory indicates success relies on the price elasticity of demand for enslaved individuals; if demand is elastic, reducing prices might be effective.

  • Graph Analysis: Include Supply/Demand curves illustrating the effect of price changes on quantity demanded.

Sample Free Response Questions

Utility Maximization Rule

• Rule: Marginal Benefit (MB) must equal Marginal Cost (MC).

1. Calculate Marginal Utility (MU) and MU per Price (MU/P) for each DVD and CD to find the optimal combination within budget (CDs: $10, DVDs: $20).

2. Explain utility-maximizing combination of CDs/DVDs at $100:

   • Determine optimal units purchased maximizing total utility.

3. For increased budget of $130, apply similar calculations to maximize utility.

Additional Resources

• Videos provided for understanding concepts better.

• Mr. Clifford's Lectures: Helpful for deeper insights into elasticity.