Econ 2610 - Youngstown State University



Econ 2610

STUDY GUIDE FOR EXAM 1*

* The study guide is not necessarily exhaustive. It is intended to give you direction as to what you should focus on your limited study time.

Fundamentals

-The definition of economics

-Key ideas in economics

-It’s the marginal benefits and marginal costs that matter, not sunk costs

-Calculating marginal benefits and costs to determine optimal Q

-People follow incentives

-Opportunity costs

-What they are and why they matter

Comparative Advantage

-Production possibilities frontier

-Determining points along it and calculating opportunity costs as move along it.

-Theory of comparative advantage

-Calculating opportunity costs

-Determining comparative and absolute advantages

-Potential gains from specialization and trade

-The real shape of the PPF and what it means for opportunity costs

Supply and Demand

-What determines prices in markets

-Shapes of demand and supply curves

-Reservation prices to consumers and producers

-Distinction between a change in quantity demanded or demand, quantity supplied or supply

-How we reach equilibrium in a market

-Excess demand, excess supply and expected impacts to price

-Shifters of demand

-Inferior and normal goods, substitutes vs. complements, etc.

-Shifters of supply

-Changes in the price of an input, technology, etc.

-How changes in supply and/or demand affect equilibrium price and quantity.

-Simultaneous shifters

Markets and Efficiency and Government

-Consumer and Producer Surplus

-What consumer and producer surplus represent and how to calculate them

-Price ceilings and price floors

-Examples of each, what they cause (shortages and surpluses), and deadweight loss areas.

-Sources of market failure

Price Elasticity

-How to calculate it and interpret it

-Elastic, inelastic, and unit-elastic

-Perfectly elastic and perfectly inelastic demand

-Link between price elasticity and revenue (expenditures)

-Determinants of elasticity

-Other elasticities*

-Income elasticity (luxuries, necessities, vs. inferior goods)

-Cross price elasticity (substitutes vs. complements)

-Price elasticity of supply

*I’m not sure if we’ll have time to get through other elasticities before the exam.

PRACTICE PROBLEMS:

Note: I will post the answers to these problems on my website by Monday (09/25).

It is also necessary to review the book, the assignment, quizzes and your notes in addition to these (they’re complements to this study guide, not substitutes). Enjoy the questions!

Use the following table to answer question 1.

Q Total Benefit Total Cost

0 0 0

1 40.00 20.00

2 65.00 40.00

3 80.00 60.00

4 90.00 80.00

5 90.00 100.00

a. The table above represents the total benefits and the total costs associated with playing rounds of golf in a month. How many rounds of golf will this person play?

b. If there was a membership cost of $50 to join this golf club, how many rounds will this person play?

c. If marginal costs increased to $26.00 per round, how many rounds would he play?

2. In order to discourage people from engaging in an activity, one should __________ the benefits and __________ the costs associated with that activity.

3. Describe the opportunity cost of working on this study guide right now.

4. A person is choosing between 3 activities, all of which don’t involve any explicit costs. A offers $20 in benefits, B offers $15 in benefits, and C offers $10 in benefits. Which activity will this person choose and what is the opportunity cost associated with that activity.

5) According to the principle of comparative advantage, everyone does best by specializing in _________________, regardless of their absolute advantages.

6) Use the following production possibilities frontier to answer question 6.

[pic]

The figure above represents the production possibility frontier for ipods and laptops for Apple.

a.) What is the opportunity cost of increasing the production of ipods from 800 to 1000 equal?

b.) What about the opportunity cost of increasing the production of laptops from 300 to 700?

c.) What happens to the opportunity cost as we devote more and more resources to the production of either good?

The graph above represents Tom’s PPC for two activities, X and Y.

7a.) The opportunity cost to Tom of doing 1 X is ____.

7b.) The opportunity cost to Tom of doing 1 Y is ____.

7c.) Point A on the graph above equals ____.

8) Use the following table to answer the following questions:

California Texas

Oranges 60 tons/year 100 tons/year

Rice 60 tons/year 200 tons/year

8a.) Find the opportunity cost to each state for producing 1 ton of each product.

8b.) Who has a comparative advantage in each task?

8c.) Suppose without considering their comparative advantages, California produces 25 tons of oranges and 35 tons of rice, while Texas produces 25 tons of oranges and 150 tons of rice. What is the potential total amount of oranges and rice gained if each country specializes in what they have a comparative advantage in?

9) Suppose the opportunity cost to the U.S. of producing 1 X is 20 Y. The opportunity cost to Mexico of producing 1 X is 15 Y.

a) Who has an absolute advantage in task X and who has an absolute advantage in task Y?

b) Who has a comparative advantage in task X and who has a comparative advantage in task Y?

c) How could we maximize production of both X and Y?

9.) Use the following demand and supply table to answer the following questions.

Price Qdemanded Qsupplied

$0.25 500 200

$0.50 400 400

$0.75 200 600

$1.00 100 800

9a.) What is the equilibrium price and quantity in the market shown above?

9b.) If the price is currently $0.75, then there will be an excess____________, the market price

will __________, quantity supplied will _________, and quantity demanded will ________.

10) When there is an excess demand (shortage) in a market, what can you predict will happen to the price, quantity supplied, and quantity demanded in that market?

11a) The reservation price to consumers represents _____________ and is based on ___________.

11b.) The reservation price to producers represents _____________ and is based on ___________.

12) An individual will buy a good as long as the price is (greater than or less than) their reservation price? A seller will sell a good as long as the price is (greater than or less than) their reservation price?

Use the following graph, representing two demand curves to answer question 13:

13a). Refer to the graph above, and assume it represents a normal good. If consumers see their incomes decrease, their likely response will best be represented by which arrow?

13b.) Refer to the graph above, and assume it represents an inferior good. If the price of the good

rises, their likely response will best be represented by which arrow?

14) An increase in “demand” refers to _____________ ; an increase in “quantity demanded” refers to _____________?

15) Fill in the blanks to indicate how the following changes will affect supply or demand.

a) An increase in the price of a complement will cause _____ to shift ______.

b) A decrease in income will cause ____ to shift _____ for an inferior good.

c) An improvement in the technology will cause _____ to shift ______.

d) An increase in the price of an input will cause _____ to shift ______.

e) An increase in the price of a good will cause ______ to shift _____.

16) The supply of good A is lower than the supply of good B. If the two goods face equal demand curves, which good will have the higher price?

17) Assume the price of milk increases. What do you expect to happen to the equilibrium price and quantity in the market for cheese (milk is used as an input in the production of cheese)?

18) A decrease in equilibrium price and a decrease in equilibrium quantity could be produced by

a(n) _________, other things constant?

19a.) On a clearly labeled set of axes, illustrate the probable effects of a decrease in the price of cattle feed, to the supply and/or demand for beef. Start with an equilibrium labeled (Po, Qo) and label the new equilibrium (P1, Q1).

Explain what changed: Demand or quantity demanded? Supply or quantity supplied?

19b.)Assume after the decrease in the price of cattle feed, the price of chicken increases. What is the likely effect to the supply and/or demand for beef, if any? Explain what changed: Demand or quantity demanded? Supply or quantity supplied?

Furthermore, if the new equilibrium is (P2, Q2), do you expect P2 and Q2 to be greater than or less than P1 and Q1?

20) An individual expects to receive $10 in benefits from a good that cost $2 to produce. If the price of the good is $2, what is the amount of consumer and producer surplus associated with this transaction?

21) Explain why economists prefer to allow markets to reach the natural equilibrium over alternatives such as price controls?

22) Use the following diagram to answer the following questions.

[pic]

22a) What is the consumer and producer surplus in the above market associated with the 500th unit?

22b) What would happen if the government set a price ceiling equal to $30?

22c) What would happen if the government set a price ceiling equal to $80?

23) If supply decreases at the same time that demand increases, what do you expect to happen to the equilibrium price and quantity?

Q Reservation Price of Buyers Reservation Price of Sellers

1 $150.00 $40.00

2 $100.00 $50.00

3 $80.00 $60.00

4 $70.00 $70.00

5 $60.00 $80.00

24a. What is the equilibrium price and quantity in the market shown above?

24b. If the market is in equilibrium, what is the consumer and producer surplus associated with the first quantity in the market?

25. Use the following diagram to answer the question below.

[pic]

a. Calculate the total amount of consumer and producer surplus when the market above is in equilibrium.

b. Calculate the deadweight loss associated with a price ceiling being set at a price of $50 in the market above.

c. If the government wants to reduce the price of a good, rather than set a price ceiling they can enact policies that either ________ supply or _______ demand of the good.

26. What is the formula for price elasticity of demand?

27 If demand is price elastic, this means that the percentage change in quantity demanded is ______________ compared to the percentage change in price.

28. If the price elasticity of demand equals -2.5, a 3% increase in price will have what effect to quantity demanded?

29. The price of TVs decreases from $400 to $300 and quantity demanded increases from 6,000 to 7,000. Calculate the price elasticity of demand for TVs using the basic percentage formula. Are TVs inelastic, elastic or unit-elastic?

30. Draw a perfectly elastic demand curve and perfectly inelastic demand curve. What does the price elasticity of demand for each equal?

31. Determine whether demand for the following goods are elastic, inelastic, or unit elastic:

a.) Price increases by 10% and revenue increases by 10%.

b.) Price increases by $10 and revenue decreases by 12%.

c.) Price increases by 10% and quantity demanded decreases 10 units.

d.) Price decreases by 10% and revenue doesn’t change.

e.) Price decreases by 10% and revenue increases from $400 to $500.

f.) Price decreases by 5% and quantity demanded increases by 5%.

32. A good has a price elasticity equal to -0.6 and quantity demanded is 10,000. What is the new quantity demanded when price decreases by 10%? What will happen to total revenue (will it increase or decrease)?

33. Income increases by 3% and quantity demanded decreases from 100 to 95. What is the income elasticity of demand for this good? Is it a normal or inferior good?

34. The cross price elasticity between good B and C is +2, and the price of good C decreases by 6%. What happens to the quantity demanded for good B? Are these goods complements or substitutes?

35. Is the cross-price elasticity positive or negative for the following items?

a. tuna and peanut butter.

b. beer and pretzels.

36. Fill in the blank with “positive” or “negative”

The income elasticity of demand is ____ for normal goods and ____ for inferior goods; the cross price elasticity is ___ for complements and ____ for substitutes; the price elasticity of supply is ____.

-----------------------

ipods

800

500

1000

700 850

300

laptops

90

60

A 30

X

Y

P

C

B

A

D

Q

D

80

500 1000 1500

50

10

S

30

Q

P

100

125

D

100

2000 4000 6000

75

25

S

50

Q

P

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