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Kristina DurhamFinal Exam Review (Answers) ECO2023December 7, 2020Disclaimer: this final review guide does not cover every topic that may be on the exam.Zoom poll key:CDABFalse (B)DADCTrue (A)Module 1: FundamentalsMicroeconomics: The study of the economy at the small-scale level, examining individuals and specific markets.Macroeconomics: The study of the economy at the large-scale level, examining total output, the price level, and other aggregate measures in the economy.Resources: land, labor, capital, entrepreneurial abilityOpportunity cost: The value of the next-best forgone alternative; the value of the opportunity that you gave up when you chose one activity, or opportunity, instead of another.Not a monetary cost/something that you buyRational decision making: people make choices in their best interest (self interest), at the margin (evaluate the additional benefit versus additional cost of an action), and optimization (want to maximize the overall benefit of an action subject to its cost, if the MB is greater than or equal to marginal cost)Marginal benefits and cost:The amount of gain or cost that comes with producing or consuming one additional unit of a goodOptimal output is when marginal benefits equal marginal costWith increased production… marginal benefit tends to fall and marginal cost tends to rise because of diminishing marginal returnsProduction Possibilities Frontier: Source: Principles of Economics 2eAbsolute advantage: the ability to produce a good using fewer inputs than another producerIt is possible for a producer to have the absolute advantage in both goods Comparative Advantage: The ability to produce a good or service at a lower relative opportunity cost than another producerKey word here is “relative.” Comparative advantage differs from absolute advantage because a producer can only have the comparative advantage in one goodSpecialization: producing a single good rather than multiple goods Use specialization to increase total productionSource: Principles of Economics 2eTerms of trade: price of a good in terms of anotherMust be beneficial for both participants: seller’s opportunity cost < price < buyer’s opportunity costThe terms of trade must be higher than the seller’s opportunity cost for that good but lower than the buyer’s opportunity costGains from trade: the benefit to a buyer or seller that comes from trading one good for another (the additional benefit does not have to be monetary)Circular flow model: a model that describes how goods, services, resources, and money flow back and forth in an economySource: Principles of Economics 2eModule 2: DemandLaw of Demand: A principle in economics which states that as the price of a good, service, or resource rises, the quantity demanded will decrease, and vice versa, all else held constantDemand curves are always downward slopingIncome effectDiminishing marginal utilitySubstitutionChange in Quantity Demanded: caused by a change in price, moves ALONG the demand curve, does NOT shift the whole curveIncrease in quantity demanded: move down & to the right on the curveDecrease in quantity demanded: move up & to the left on the curveChange in Demand: caused by a NONPRICE determinant (ex: change in income, taxes, substitute price change, number of buyers, tastes and preferences, expectations) and causes a shift of the whole demand curveIncrease in demand: shift rightDecrease in demand: shift leftNormal good: as income increases, demand increases (ex nice clothing)Inferior good: as income increases, demand decreases (ex ramen noodles)Substitutes: goods that are viewed as replacements for each other (ex coke & pepsi, butter & margarine, mittens & gloves, pizza & calzones, coffee & tea, etc)Complements: goods that are used or consumed with each other (ex peanut butter and jelly, cereal and milk, coffee & pastries, cell phones & cell phone cases, etc)Module 3: Supply Law of Supply: A principle in economics that states that as the price of a good, service, or resource rises, the quantity supplied will increase, and vice versa, all else held constantChange in quantity supplied: shift ALONG the supply curve, caused by a price change Increase in quantity supplied: shift along the curve to the right/upDecrease in quantity supplied: shift along the curve to the left/downChange in supply: shift of the whole curve, caused by nonprice determinants of supplyIncrease in supply: shift of the whole curve to the rightDecrease in supply: shift of the whole curve to the leftSource: Khan AcademyNonprice determinants of supplySubsidies TaxesResourcesTechnologyPrice expectationsNumber of sellersModule 4: Market Equilibrium and PolicyEquilibrium price: price at which the quantity supplied of a good equals the quantity demanded Price where the demand and supply curves intersectEquilibrium quantity: quantity traded when the quantity supplied of a good equals its quantity demanded Quantity where the demand and supply curves intersectSurplus: quantity supplied is greater than the quantity demanded at the current market price (aka excess supply)Shortage: quantity demanded is greater than the quantity supplied at the current market price (aka excess demand)Which of the following statements does not describe equilibrium?A) Quantity demanded equals quantity supplied at the same price.B) The market is in balance.C) There are no shortages or surpluses.D) Equilibrium is a goal that is seldom achieved in the real world.(source: Professor Buhagiar’s Module 4 Self Test Questions)Change in equilibrium: caused by a change in supply or demandDon’t get “shift happy” and shift both curvesFor example, show the effect on the market for vitamins after a study comes out saying that everyone should take vitamins every day. The demand curve for vitamins will shift to the right because a nonprice determinant of demand (preference/taste for vitamins) has increased demand. However, do not shift the supply curve, because the new equilibrium once demand has increased shows the increase in quantity supplied.Price ceilings: maximum price for a good (imposed by government)A binding price ceiling must be below equilibriumPrice floors: minimum price for a good (imposed by government)binding must be above equilibriumTaxes on suppliers and demandersShift supply curve UP (for a tax placed on suppliers)Tax is not the same as other nonprice determinants of supplyShift demand curve DOWN (for a tax placed on demanders)Tax is not the same as other nonprice determinants of demandTax revenue: amount of tax multiplied by quantity of good soldModule 5: Market EfficiencyConsumer surplus: The difference between the maximum price consumers are willing and able to pay for a good or service and the price they actually payArea below demand curve and above price paid by consumersProducer surplus: The difference between the price producers receive for a good or service and the minimum price they are willing and able to acceptArea above the supply curve and below the price taken by producersEconomic surplus: sum of consumer and producer surplus (total surplus in the market)Deadweight loss: value of economic surplus lost when a market is not allowed to adjust to its competitive equilibrium Productive efficiency: producing output at the lowest possible average total cost of production, using the fewest resources possible to produce a good or service Most efficient production, demand doesn’t matterAllocative efficiency: producing goods or services that are most wanted by consumers in such a away that their marginal benefit equals their marginal costDemand does matterMB=MCPrice ceilings, price floors, and Taxes: cause disequilibrium in the marketb. Find the new equilibrium price paid by consumers, the price received by suppliers, and the new equilibrium quantity of bottled water traded in the market.c. Shade the area that represents the tax revenue collected by the government. How much revenue is collected?d. Shade the area that represents the consumer surplus generated after the imposition of the tax. How much consumer surplus is generated in the market?e. Shade the area that represents the producer surplus generated after the imposition of the tax. How much producer surplus is generated in the market?f. Shade the area that represents the deadweight loss generated by the imposition of the tax. How much deadweight loss does the tax generate?Source: Principles of Economics 2e, page 141-142Module 6: ElasticityElasticity of demand= %change in quantity demanded/% change in price%change in quantity demanded= (Q2-Q1)/Q1 x 100%change in price= (P2-P1)/P1 x 100Answer: -1.14Midpoint formula (for both elasticity of supply & demand): (Q2-Q1)/ [(Q2+Q1)/2] x100Divided by:(P2-P1)/ [(P2+ P1)/2] x100Q2= new quantity demanded Q1= old quantity demandedP2= new priceP1= old priceElastic demand: price elasticity of demand greater than 1 (absolute value)If the price changes by 1%, quantity demanded changes by more than 1% as a resultInelastic demand: price elasticity of demand is less than 1 (absolute value)If the price changes by 1%, quantity demanded changes by less than 1% as a resultUnit elastic demand: price elasticity of demand equal to 1If the price changes by 1%, quantity demanded changes by 1%Total revenue: quantity multiplied by price If total revenue decreases with a decrease in price, this shows inelastic demand, because the percentage increase in quantity demanded was smaller than the percentage decrease in priceDeterminants of elasticitySubstitutes: many substitutes=elastic demandIncome: more expensive goods’ prices are more sensitive to a small change (25% price raise of a $1 candy bar vs a $25,000 car)Necessities: less elasticLuxuries: more elasticTime: demand is relatively inelastic in the short run (people don’t have time to search for substitutes), demand is relatively elastic in the long run (people have time to find a substitute if the price of one good rises)Cross-price elasticity of demand: %change of quantity demanded in good B/%change in price of good ASubstitutes: cross price elasticity will be positiveComplements: cross price elasticity will be negativeIncome elasticity of demand: measure of how responsive demand is to a change in consumer income%change in quantity demanded/%change in incomeNormal good: positive income elasticity of demandInferior good: negative income elasticity of demandPrice elasticity of supply: a measure of how responsive quantity supplied is to a change in price%change in quantity supplied/% change in price%change in quantity supplied= (Q2-Q1)/Q1 x 100%change in price= (P2-P1)/P1 x 100Elastic, inelastic, unit elastic supplySame as demand (see above)Supply in the immediate period, short run, and long runImmediate: time period in which producers cannot increase their use of economic resources to increase quantity suppliedSupply is perfectly inelastic Short run: time period in which at least one input of production is unchanging but other inputs can be changed Supply is relatively elasticLong run: time period in which all inputs of production can be changed Supply is most elasticModule 7: ProductionExplicit and Implicit CostsExplicit costs: monetary payments made for the use of land, labor, capital, and entrepreneurial ability owned by others (aka accounting costs)Implicit costs: the opportunity costs of using owned resources, costs for which no monetary payment is explicitly madeEconomic Costs: sum of explicit and implicit costsAccounting Profit= Total Revenue- Explicit CostsEconomic Profit= Total Revenue-Economic CostsShort Run relationshipsTotal Product=total outputMarginal Product= change in TP/change in laborAverage Product= total product/laborDiminishing marginal returns: marginal product of the next unit of a variable resource utilized is less than that of the previous variable resourceShort run relationshipsFixed costs: do not change with the amount of output producedVariable costs: change with output produced, increase with production and decrease with productionTotal costs: sum of fixed and variable costsShort run relationshipsAverage costsAverage fixed costs: total fixed cost divided by the amount of output producedAverage variable costs: total VC divided by the amount of outputAverage total costs: TC divided by total output Short run relationshipsMarginal cost: the additional cost associated with 1 more unit of an activityChange in total cost/change in quantityLong run relationshipsLong run average total cost curve: a curve showing the lowest average total cost possible for any given level of output when all inputs of production are variableLong run relationshipsEconomies of scale: long-run average total cost of production decreases as production increasesConstant returns to scale: long-run ATC of production remains constant as production increasesDiseconomies of scale: long-run ATC of production increases as production increasesModule 8: Perfect CompetitionCharacteristics of perfect competition: large number of sellersstandardized productprice takerseasy entry and exit to marketPrice taker: does not influence price, accepts market pricePrice=marginal revenue=average revenueOperations in the short runProduce where MR=MCAnything below this quantity leaves additional production undone where revenue exceeds costModule 9: Pure MonopolyPure monopolySingle sellerNo substitutesPrice makersBarriers to entryMonopoly power: ability of a monopoly to influence prices by controlling the quantities that it produces in the marketMarginal revenue: change in a firm’s total revenue that results from a one-unit change in output produced and soldChange in total revenue/change in quantityAka (new TR-old TR)/(new Q – old Q)Pure monopoly pricingProfit maximizationMR=MCEconomic profitEconomic EfficiencyAllocative efficiency: for a pure monopoly, look for where the marginal cost curve crosses the demand curveProductive efficiency: to find the profit maximizing level of output, see where MR and MC curves intersect, then project up to the demand curve to find the price RegulationNatural monopoly: An industry in which economies of scale are so extensive that the market is better served by a single firmUnregulated monopoly price: The profit-maximizing price that will result from an unregulated monopolistic marketRegulated normal profit price: A regulated price that is equal to the average total cost of productionRegulated competitive price: A regulated price that is equal to the marginal cost of productionModule 10: Monopolistic Competition and OligopolyMonopolistic competitionRelatively large number of sellersDifferentiated product Some control over priceRelatively easy entry and exitShort run equilibriumMR=MCEconomic Efficiency: monopolistically competitive markets are not allocatively efficient Oligopolistic competitionFew large producersStandardized or differentiated productEntry barriersPrice makersMutually interdependent ................
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