ECON 102 Exam 2 - Custom Scholars
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# ECON 102 Exam 2

question
Elasticity
The sensitivity of quantity demanded or quantity supplied to a variable change
question
Percent change formula
%Δ = (new - old)/old
question
Demand Elasticity
Determinants of Demand Elasticity:
i. The number of substitutes and the quality of substitutes for the good
ii. The share of income spent on the good (i.e. milk vs. a car)
iii. Passage of time: short run is more inelastic while long run is more elastic
Note: A firm's revenue is at its maximum when Ed = -1
question
Elasticity Formula
Elasticity of Demand = (% change in quantity demanded)/(% change in price)
i. Elasticity of demand is always less than zero
ii. Elastic: Ed < -1
iii. Inelastic: -1 < Ed < 0
iv. Unit Elastic: Ed = -1
question
Point Elasticity
Elasticity of Demand = (coefficient of price or (1/slope) when Q=f(P))(price/quantity)
question
Income Elasticity
Income Elasticity of Demand = (% change in quantity demanded)/(% change in income) at a given price
i. Normal Good: positive income elasticity
a. Luxury: Ei > 1 (i.e. designer clothes)
b. Necessity: 0 < Ei < 1 (i.e. milk)
ii. Inferior Good: negative income elasticity
iii. If Ei = 0, there's no relation between income and quantity demanded
question
Cross Price Elasticity
Cross-price elasticity of demand = (% change in quantity demanded of X)/(% change in price of Y)
i. Measures the relative change in the quantity demanded of a good in response to change in the price of another good
ii. For substitutes: Exy will be positive
iii. For complements: Exy will be negative
iv. For unrelated goods: Exy will be zero
question
Utility
The satisfaction from consuming a good or service (happiness)
question
Total Utility (TU)
The total satisfaction resulting from the consumption of a good or service
question
Marginal Utility (MU)
The additional satisfaction obtained by consuming one more unit of a good (the derivative of TU)
question
Diminishing Marginal Utility
Increasing consumption leads to smaller increases in happiness
question
Optimal Consumption
i. Maximum utility is subject to budget constraints
ii. Goal: get the most "bang for our buck"
iii. Spend last \$ such that (MUx/Px) = (MUy/Py)
iv. If one side of the above equation is larger than the other, consume less of that good and more of the other one
question
Accounting Profit
Accounting Profit = (total revenue) - (explicit costs)
Note: explicit costs include costs that managers must take account of because they must be paid (i.e. wages, taxes, raw materials, insurance)
question
Economic Profit
Economic Profit = (accounting profit) - (implicit costs) = (total revenue) - ( explicit costs + implicit costs)
Note: implicit costs include expenses that managers do not have to pay out of pocket and hence do not normally explicitly calculate (i.e. opportunity cost of owned inputs such as capital, owner-provided labor above salary paid)
question
Economic Rent
A payment for the use of any resource over and above its opportunity cost
i. Allocates resources to highest valued use
ii. Rent may be larger if competition is lower or resources can't be replicated (i.e. actor, singer)
question
Profits
Profit = revenue - "costs"
question
Production Function
Q = f (K, L)
where Q is output, and K and L are the inputs capital and labor
i. Short Run: capital is fixed (k bar)
ii. Long Run: all inputs are variable (K and L)
Note: SR and LR are not arbitrary time periods (i.e. weeks or months)
question
Average Product of Labor (APL) and Marginal Product of Labor (MPL)
In the short short run, both APL and MPL are hill-shaped due to diminishing marginal product (i.e. garbage truck example)
question
Marginal Cost (MC)
The additional change in total costs due to an increase in output (u-shaped in SR)
question
Average Total Costs (ATC)
The total cost (TC) divided by the number of units produced (Q); "cost per unit" (u-shaped in SR)
question
Average Variable Cost (AVC)
Variable costs are costs that vary directly with output (Q) (i.e. wages paid to workers, purchases of materials). The AVC is the total variable costs (TVC) divided by the number of units produced (Q) (u-shaped in SR).
question
Average Fixed Costs (AFC)
Fixed costs are costs that do not vary with output (Q) (i.e. monthly office rent, insurance). The AFC is the total fixed costs (TFC) divided by the number of units produced (Q) (not u-shaped in SR).
Note: AFC will always decrease as we produce more output because TFC doesn't change and Q increases
question
Relationship Between Product and Costs
MC = (wage)/(MPL)
question
Shape of Product and Cost Curves
Product curves are u-shaped in the SR while except for AFC, cost curves are hill-shaped (due to diminishing MP)
question
Average and Margin
The average follows the margin
question
Long-Run Average Cost Curve (LRAC)
i. Illustrates the minimum average cost of producing any given output, given current technology and input prices (L and K are variable)
ii. Curve is "saucer-shaped" because of economies of scale
question
Economies of Scale
i. "Double inputs, more than double output"
ii. LRAC decreases as Q increases
iii. Occurs at lowest production levels
iv. Does not persist indefinitely
v. Caused by things like specialization of all inputs, improved equipment, larger volume equipment, etc.
question
Constant Returns to Scale
i. "Double inputs, exactly double output"
ii. LRAC remains constant as Q increases
iii. Occurs at mid-range production
question
Diseconomies of Scale
i. "Double inputs, less than double output"
ii. LRAC increases as Q increases
iii. Occurs at highest production levels
iv. Caused by things like coordination difficulties, communication costs, etc.
question
Minimum Efficient Scale (MES)
i. The lowest output level at which LRAC is at a minimum
ii. A small MES signifies a "large" number of "small" firms (easy to join industry and compete)
iii. A large MES signifies a "small" number of "large" firms (difficult to join but not as competitive) (i.e. car industry)
question
Very Long Run
Changes that affect production and cost in the very long run:
i. New Techniques (process innovation)
ii. Improved Inputs (i.e. computer technology)
iii. New Products (product innovation) (i.e. Chrysler Dodge Caravan)
A firm can respond to an input price change in two ways:
i. Substitute away from the input (long run response)
ii. Innovate away from the input (very long run response)
question
Health Care Costs
Health care costs are large because the distribution of them is very skewed (50% of the costs are incurred by 5% of the population). Overall, health care costs are increasing because people generally have longer lifespans so the average age is increasing, and people want the best and newest care, demanding expensive new technologies.
question
Adverse selection states that only "unhealthy" people "should" buy insurance, something that consequently would increase premium prices. However, even risk-adverse, healthy people buy insurance because of imperfect information (we don't know if or when we will become "unhealthy").
question
Moral Hazard
The moral hazard of health care is that an individual has both the incentive and ability to shift costs to another party, thus causing the benefits to stay the same and the costs to decrease
question
Pros and Cons of Health Care Reform
Pros:
i. Rationing: limiting the availability of care that costs society more to produce than it's worth to patients
ii. Health care paid for by the rich
Cons:
i. Rationing
ii. Moral Hazard
iii. Long waits
1 of 35
question
Elasticity
The sensitivity of quantity demanded or quantity supplied to a variable change
question
Percent change formula
%Δ = (new - old)/old
question
Demand Elasticity
Determinants of Demand Elasticity:
i. The number of substitutes and the quality of substitutes for the good
ii. The share of income spent on the good (i.e. milk vs. a car)
iii. Passage of time: short run is more inelastic while long run is more elastic
Note: A firm's revenue is at its maximum when Ed = -1
question
Elasticity Formula
Elasticity of Demand = (% change in quantity demanded)/(% change in price)
i. Elasticity of demand is always less than zero
ii. Elastic: Ed < -1
iii. Inelastic: -1 < Ed < 0
iv. Unit Elastic: Ed = -1
question
Point Elasticity
Elasticity of Demand = (coefficient of price or (1/slope) when Q=f(P))(price/quantity)
question
Income Elasticity
Income Elasticity of Demand = (% change in quantity demanded)/(% change in income) at a given price
i. Normal Good: positive income elasticity
a. Luxury: Ei > 1 (i.e. designer clothes)
b. Necessity: 0 < Ei < 1 (i.e. milk)
ii. Inferior Good: negative income elasticity
iii. If Ei = 0, there's no relation between income and quantity demanded
question
Cross Price Elasticity
Cross-price elasticity of demand = (% change in quantity demanded of X)/(% change in price of Y)
i. Measures the relative change in the quantity demanded of a good in response to change in the price of another good
ii. For substitutes: Exy will be positive
iii. For complements: Exy will be negative
iv. For unrelated goods: Exy will be zero
question
Utility
The satisfaction from consuming a good or service (happiness)
question
Total Utility (TU)
The total satisfaction resulting from the consumption of a good or service
question
Marginal Utility (MU)
The additional satisfaction obtained by consuming one more unit of a good (the derivative of TU)
question
Diminishing Marginal Utility
Increasing consumption leads to smaller increases in happiness
question
Optimal Consumption
i. Maximum utility is subject to budget constraints
ii. Goal: get the most "bang for our buck"
iii. Spend last \$ such that (MUx/Px) = (MUy/Py)
iv. If one side of the above equation is larger than the other, consume less of that good and more of the other one
question
Accounting Profit
Accounting Profit = (total revenue) - (explicit costs)
Note: explicit costs include costs that managers must take account of because they must be paid (i.e. wages, taxes, raw materials, insurance)
question
Economic Profit
Economic Profit = (accounting profit) - (implicit costs) = (total revenue) - ( explicit costs + implicit costs)
Note: implicit costs include expenses that managers do not have to pay out of pocket and hence do not normally explicitly calculate (i.e. opportunity cost of owned inputs such as capital, owner-provided labor above salary paid)
question
Economic Rent
A payment for the use of any resource over and above its opportunity cost
i. Allocates resources to highest valued use
ii. Rent may be larger if competition is lower or resources can't be replicated (i.e. actor, singer)
question
Profits
Profit = revenue - "costs"
question
Production Function
Q = f (K, L)
where Q is output, and K and L are the inputs capital and labor
i. Short Run: capital is fixed (k bar)
ii. Long Run: all inputs are variable (K and L)
Note: SR and LR are not arbitrary time periods (i.e. weeks or months)
question
Average Product of Labor (APL) and Marginal Product of Labor (MPL)
In the short short run, both APL and MPL are hill-shaped due to diminishing marginal product (i.e. garbage truck example)
question
Marginal Cost (MC)
The additional change in total costs due to an increase in output (u-shaped in SR)
question
Average Total Costs (ATC)
The total cost (TC) divided by the number of units produced (Q); "cost per unit" (u-shaped in SR)
question
Average Variable Cost (AVC)
Variable costs are costs that vary directly with output (Q) (i.e. wages paid to workers, purchases of materials). The AVC is the total variable costs (TVC) divided by the number of units produced (Q) (u-shaped in SR).
question
Average Fixed Costs (AFC)
Fixed costs are costs that do not vary with output (Q) (i.e. monthly office rent, insurance). The AFC is the total fixed costs (TFC) divided by the number of units produced (Q) (not u-shaped in SR).
Note: AFC will always decrease as we produce more output because TFC doesn't change and Q increases
question
Relationship Between Product and Costs
MC = (wage)/(MPL)
question
Shape of Product and Cost Curves
Product curves are u-shaped in the SR while except for AFC, cost curves are hill-shaped (due to diminishing MP)
question
Average and Margin
The average follows the margin
question
Long-Run Average Cost Curve (LRAC)
i. Illustrates the minimum average cost of producing any given output, given current technology and input prices (L and K are variable)
ii. Curve is "saucer-shaped" because of economies of scale
question
Economies of Scale
i. "Double inputs, more than double output"
ii. LRAC decreases as Q increases
iii. Occurs at lowest production levels
iv. Does not persist indefinitely
v. Caused by things like specialization of all inputs, improved equipment, larger volume equipment, etc.
question
Constant Returns to Scale
i. "Double inputs, exactly double output"
ii. LRAC remains constant as Q increases
iii. Occurs at mid-range production
question
Diseconomies of Scale
i. "Double inputs, less than double output"
ii. LRAC increases as Q increases
iii. Occurs at highest production levels
iv. Caused by things like coordination difficulties, communication costs, etc.
question
Minimum Efficient Scale (MES)
i. The lowest output level at which LRAC is at a minimum
ii. A small MES signifies a "large" number of "small" firms (easy to join industry and compete)
iii. A large MES signifies a "small" number of "large" firms (difficult to join but not as competitive) (i.e. car industry)
question
Very Long Run
Changes that affect production and cost in the very long run:
i. New Techniques (process innovation)
ii. Improved Inputs (i.e. computer technology)
iii. New Products (product innovation) (i.e. Chrysler Dodge Caravan)
A firm can respond to an input price change in two ways:
i. Substitute away from the input (long run response)
ii. Innovate away from the input (very long run response)
question
Health Care Costs
Health care costs are large because the distribution of them is very skewed (50% of the costs are incurred by 5% of the population). Overall, health care costs are increasing because people generally have longer lifespans so the average age is increasing, and people want the best and newest care, demanding expensive new technologies.
question
Adverse selection states that only "unhealthy" people "should" buy insurance, something that consequently would increase premium prices. However, even risk-adverse, healthy people buy insurance because of imperfect information (we don't know if or when we will become "unhealthy").
question
Moral Hazard
The moral hazard of health care is that an individual has both the incentive and ability to shift costs to another party, thus causing the benefits to stay the same and the costs to decrease
question
Pros and Cons of Health Care Reform
Pros:
i. Rationing: limiting the availability of care that costs society more to produce than it's worth to patients
ii. Health care paid for by the rich
Cons:
i. Rationing
ii. Moral Hazard
iii. Long waits

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