ECON 208 Midterm

question

Economics

answer

study of the use of scarce resources to satisfy unlimited human wants

question

3 factors of production

answer

land, labour, capital

question

Capital

answer

produced means for further production

question

Opportunity cost

answer

value of the next best alternative that is forgone when one alternative is chosen

question

Production possibility boundary

answer

maximum combination of production given your labour endowment

question

Productive efficiency

answer

using the least possible resources

question

Allocative efficiency

answer

using resources where they are most highly valued

question

2 reasons for PPB to shift out

answer

more producers, more efficiency

question

Economic growth

answer

improvement of the PPB (shifts out), due to more resources or technological improvements

question

4 key economic problems

answer

1. What is produced and how (production)
2. What is consumed and by whom (consumer behaviour)
3. Why are resources sometimes idle
4. Is productive capacity growing

question

Microeconomics

answer

study of causes & consequences of allocation of resources as it is affected by the workings of the price system

question

Macroeconomics

answer

study of the determination of economic aggregates such as total output, employment, and growth

question

Producer and consumer behaviours

answer

1. self-interested
2. profit/utility/satisfaction-maximizing
3. rational

question

Invisible hand

answer

term economists use to describe the self-regulating nature of the marketplace; set of prices

question

How is spontaneous, natural order generated?

answer

producers/consumers responding to price in their best interests

question

Two ways government is involved in free market

answer

1. provision of property rights
2. freedom of contract

question

Two ways government enforces their roles

answer

1. police
2. court of law

question

Marginal

answer

refers to the last unit

question

Market failure

answer

market fails to generate an efficient outcome, and government may need to intervene; total surplus not maximized

question

3 reasons for government to intervene in a market

answer

1. inefficiently allocated resources
2. providing public goods
3. achieving equity / mitigation of purchasing power to remediate unfair distribution of commodities

question

Globalization

answer

increased importance of international trade

question

2 things globalization is enabled by

answer

1. revolution in information technology
2. rapid reduction in transportation costs

question

Challenges of globalization

answer

1. human rights
2. environmental
3. production standards
4. global sellers have lower costs than local sellers

question

Two ways to increase local production

answer

tax and quotas on imports

question

3 types of economic systems

answer

1. traditional
2. command/centrally-planned
3. free market

question

Traditional economy

answer

production is only what they need, but economic/social mobility very limited

question

Command economy

answer

dictatorship or centrally-planned economy; no incentive to get more efficient, and unable to raise living standards

question

Free market economy

answer

constantly competing and gaining efficiency

question

Karl Marx

answer

argued that free-market economy, while certainly growth-enhancing, could not be relied on to generate a "just" distribution of output; inspired the creation of many socialist/communist systems, beginning with Soviet Union

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Normative statement

answer

depends on value judgements; what should happen

question

Positive statement

answer

matter of fact; can be false though

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Theory

answer

generalization of an observation; abstraction from reality

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3 things theory is based on

answer

1. variables
2. assumptions
3. predictions

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Variables

answer

well-defined items that can take on different values

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Assumptions

answer

1. motives (e.g. maximize satisfaction/profits)
2. direction of causation
3. conditions of application (e.g. government is irrelevant for the theory)

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Model

answer

formal presentation of a theory

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Function

answer

x = f(Px) where direction of causation is Px->x

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How to test a theory

answer

confront the predictions with evidence

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Endogenous variable

answer

value is determined within a theory

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Exogenous variable

answer

variable outside the theory that affects the variables in the theory - e.g. income

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Index

answer

measure of some variable conventionally expressed relative to a base period, which is assigned value 100

question

Value of index in given period

answer

= (absolute value in given period / absolute value in base period) x 100

question

Consumer Price Index (CPI)

answer

representation of average level of prices in economy; used to calculate rate of inflation

question

Two forms of data

answer

1. time series
2. cross-section

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Demand

answer

desire backed by purchasing power and willingness to pay

question

6 factors affecting demand

answer

1. own price
2. income
3. price of related goods
4. consumers' tastes
5. population changes
6. significant changes in weather

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Direction of causation for demand

answer

price -> quantity, ceteris paribus (negatively related)

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Ceteris paribus

answer

all other things remaining constant

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Law of demand; relation of own price (1) to demand

answer

when price rises, quantity demanded falls; when price falls, quantity demanded rises; other things remaining constant

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Relation of income (2) to demand

answer

normal goods: positive
inferior goods: negative

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Relation of price of related goods (3) to demand

answer

substitutes: positive
complements: negative

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Relation of tastes (4) to demand

answer

positive

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Relation of population (5) to demand

answer

positive

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When price changes...

answer

move along the demand curve; change in quantity demanded

question

When any variable other than price changes...

answer

shift in the demand curve (e.g. increased income shifts the demand curve rightward)

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Change in demand

answer

change in quantity demanded at every price

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Change in quantity demanded

answer

movement between points along the demand curve

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Supply curve direction of causality

answer

price -> quantity, positively related

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Minimum reservation price

answer

cost of production the producer incurs for a certain quantity produced; all the points on the supply curve

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6 factors affecting supply

answer

1. price of inputs
2. technology
3. government taxes or subsidies
4. prices of other products
5. significant changes in weather
6. number of suppliers

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Relation of price of inputs (1) to supply

answer

negative - increased price of inputs shifts leftward (higher cost of production)

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Relation of technology (2) to supply

answer

positive - increased technology increases production efficiency, shifts rightward (lower cost of production)

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Relation of taxes and subsidies (3) to supply

answer

taxes: negative
subsidies: positive

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Relation of prices of other products (4) to supply

answer

substitutes: negative (will switch to the more profitable substitute)
complements: positive (if one is profitable, so will the other)

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Equilibrium point

answer

the point at which quantity supplied equals quantity demanded; no excess of either, no upward/downward pressure

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Derivation of market demand/supply curve

answer

horizontal summation of individual demand/supply curves; as you have more individuals (and population rises), curve flattens out (and shifts right)

question

Combinations of demand and supply curve shifts

answer

1. D right, S right -> P (?), Q increase
2. D right, S left -> P increase, Q (?)
3. D left, S right -> P decrease, Q (?)
4. D left, S left -> P (?), Q decrease

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3 types of market linkages (shift equally in same direction)

answer

1. substitutes
2. input-output
3. joint-production (by-product)

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Elasticity

answer

the degree to which quantity demanded/supplied would change as a result of change in price; flexibility, responsiveness

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Elasticity formula

answer

= % change in quantity demanded / % change in price

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Calculating elasticity over an arc

answer

= ((QA-QB)/Qavg) / ((PA-PB)/Pavg)

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Calculating point elasticity

answer

= (PA/QA)/slope of D curve

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Elasticity = 0

answer

perfectly/infinitely inelastic; vertical demand curve (demand does not respond to price)

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0 < elasticity < 1

answer

inelastic

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Elasticity = 1

answer

unit elastic

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Elasticity > 1

answer

elastic

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Elasticity = infinity

answer

perfectly/infinitely elastic; horizontal demand curve (no change in price)

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3 determinants of elasticity of demand

answer

1. availability of substitutes (close substitutes tend to be elastic)
2. proportion of budget commanded by commodity (more expensive = more elastic)
3. short-run and long-run (short-run = less elastic; long-run = more elastic, more time to change behaviours)

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Total expenditure (TE)

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= P x Q

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TE if elastic

answer

increases

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TE at midpoint

answer

same

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TE if inelastic

answer

decreases

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Total revenue for producer

answer

= total expenditure for consumer

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TE graph

answer

negative parabola

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Marginal revenue (MR)

answer

= change in TR / change in Q

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MR for elastic

answer

positive

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MR for unit elasticity

answer

question

MR for inelastic

answer

negative

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Cross-price elasticity of demand

answer

= % change in quantity demanded of X / % change in price of Y

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Cross-price elasticity of demand for substitutes

answer

positive

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Cross-price elasticity of demand for complements

answer

negative

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Income elasticity of demand

answer

= % change in quantity demanded / % change in income

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Income elasticity of demand for normal goods

answer

positive

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Income elasticity of demand for inferior goods

answer

negative

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Two types of normal goods

answer

necessities and luxuries

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Income elasticity of demand for necessities

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0 < elasticity < 1

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Income elasticity of demand for luxuries

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elasticity > 1

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2 determinants of elasticity of supply

answer

1. ease of substitution (greater ease = more elastic)
2. short-run and long-run (long-run = more elastic)

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Excise tax

answer

a tax on the sale of a particular product; raises price paid by consumer and reduces price received by producer

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Direct vs. Indirect taxes

answer

Direct: you have to pay (e.g. income tax)
Indirect: burden can be shifted to consumer; impact and incidence on different individuals

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What determines burden of excise tax on producer and consumer?

answer

relative elasticities of supply and demand

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More elastic demand effect on excise tax

answer

producers pay larger share

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More elastic supply effect on excise tax

answer

consumers pay larger share

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When two demand curves intersect at a positive quantity...

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curve with flatter slope is more elastic

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When two demand curves with different slopes have same price-axis intercept...

answer

curves have same elasticity

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When two demand curves have same slope but different intercepts...

answer

outside curve is more elastic (demand increases with no change in slope)

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When two demand curves with different slopes do not intersect at any price...

answer

outside curve is less elastic

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Price floor

answer

minimum permissible price charged for a good or service; above the equilibrium price, excess supply

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Example of price floor

answer

minimum wage => unemployment (excess supply)

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Price ceiling

answer

maximum price that can be charged for a good or service

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Example of price ceiling

answer

rent control => excess demand, limited supply

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Q exchanged in disequilibrium

answer

minimum of Q demanded and Q supplied

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Black market

answer

products sold at prices violating legal price control; seller will buy at price ceiling, but sell at buyer's price, and make a profit

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3 goals of price ceilings

answer

1. restrict production
2. keep specific prices down
3. satisfy notions of equity in consumption of product temporarily in short supply

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3 effects of rent controls

answer

1. shortage of rental housing because demand > supply
2. alternative allocation scheme - landlords are picky
3. hidden (black) markets appear

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Rent control in short- and long-run

answer

short-run: inelastic (can't adjust)
long-run: landlords won't invest anymore

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Winners and losers in rent control

answer

winners: current tenants
losers: future tenants, landlords

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Quotas

answer

quantity controls; e.g. supply of maple syrup is too high, so prices would be driven down, but if quota is low, we can charge buyer's price and make profit

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Diminishing marginal utility

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Decreasing satisfaction or usefulness as additional units of a product are acquired

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Total economic surplus

answer

area below demand curve and above supply curve; consumer's surplus + producer's surplus

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Where is total surplus/welfare maximized?

answer

equilibrium; market efficiency

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Consumer's surplus (CS)

answer

the difference between the maximum price a buyer is willing and able to pay and the price actually paid; area under the demand curve, above price paid, bounded to the right by quantity demanded

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Producer's surplus (PS)

answer

difference between the price sellers receive for a good and the minimum price for which they would have sold the good; area above the supply curve, below the price made by sellers, bound to the right by quantity demanded

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Deadweight loss (DWL)

answer

reduction in total surplus that occurs as a result of a market inefficiency

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Government surplus

answer

portion of total economic surplus going to government in excise taxes

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Utility

answer

satisfaction that a consumer receives from consuming some good or service

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Marginal utility

answer

additional satisfaction obtained from consuming one additional unit of a product; different for each unit

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3 assumptions of diminishing marginal utility

answer

1. commodity must be provided in small and regular units of time
2. commodity must be in a sizeable unit
3. cases of increasing marginal utility are exceptions

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Condition for a consumer to maximize utility

answer

MUx/Px = MUy/Py

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2 effects of a price change

answer

1. alters relative price (substitution effect)
2. alters consumer's real income (income effect)

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What determines slope of demand curve?

answer

size of total effect

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Real income

answer

the purchasing power of nominal income

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Substitution effect

answer

price of one good decreases while the other is constant, causing relative decrease in price, so quantity demanded increases

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Income effect

answer

price of one good decreases with income constant, but purchasing power of income increases, so quantity demanded increases

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2 characteristics of Giffen goods

answer

1. inferior good, where decreased real income will increase purchasing power
2. takes large portion of total household expenditure => large income effect which offsets substitution effect

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Conspicuous goods

answer

goods consumed for "snob appeal"; some consumers will buy more if the price goes up, but most others in economy will still buy less (net negatively sloped demand curve)

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Paradox of value

answer

apparent contradiction between the high value of a nonessential item and the low value of an essential item

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2 important aspects of determination of price ignored by the paradox of value

answer

1. supply is just as important as demand in determination of price
2. consumers purchase units of a good until marginal value of last unit purchased is equal to its market price

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Solution to paradox of value

answer

water has high total value; high CS, and low marginal value
diamond has low total value; low CS, high marginal value

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Effect of price change; normal goods

answer

income and substitution effects in same direction

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Effect of price change; inferior goods

answer

income effect partially offsets substitution effect

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Effect of price change; Giffen goods

answer

income effect outweighs substitution effect

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Formation of market demand curve

answer

horizontal summation of individual demand curves

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6 organizations of firms

answer

1. single proprietorship
2. ordinary partnership
3. limited partnership (general & limited)
4. corporation (private & public)
5. state-owned enterprise
6. non-profit organization

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2 assumptions for all firms

answer

1. single decision-making unit
2. profit-maximizing

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4 types of inputs for production

answer

1. outputs from other firms (intermediate products)
2. nature
3. services of labour
4. services of physical capital

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Production function

answer

Q = f(K,L) where K = capital, L = labour; shows maximum output that can be produced by a combination of inputs

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Explicit cost

answer

cost associated with a transaction that actually happened

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Accounting profit

answer

= revenue - explicit costs

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Economic profit

answer

= revenue - (explicit + implicit costs)

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Implicit costs

answer

opportunity costs

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Short run

answer

time period in which quantity of some input is fixed

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Long run

answer

time period in which all factors of production can change, but technology is fixed

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Very long run

answer

time period in which all factors of production and technology can change

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Average product (AP)

answer

= total product (TP) / quantity of labour (L)

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Marginal product of labour (MP)

answer

= change in TP / change in L

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Diminishing marginal product of labour

answer

principle that if at least one input of production is fixed (capital), the marginal productivity of additional variable resources (labour) will eventually fall and contribute less and less to output

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MP and AP relationship

answer

Marginal drives the average!
When MP > AP, each additional worker increases output; both curves rise
When MP < AP, each additional worker decreases output; both curves fall
MP cuts AP at its max

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Total cost (TC)

answer

= total fixed costs (TFC) + total variable costs (TVC)

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Average total cost (ATC)

answer

= TC/Q = AFC + AVC

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Marginal cost (MC)

answer

= change in TC / change in Q = change in TVC / change in Q

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Where does MC cut AVC curve

answer

minimum

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Capacity

answer

level of output corresponding to minimum of SATC curve; largest output that can be produced with increasing average cost per unit

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Rise in price of variable factor (wage) effect on SATC

answer

TVC, TC, AVC, ATC, MC shift up

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Rise in price of a fixed factor (capital) effect on SATC

answer

TFC, AFC shift up (MC same)

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Rise in quantity of a fixed factor (capital) effect on SATC

answer

TFC, AFC shift up, MC, AVC shift down; usually becomes more productive, so AP and MP shift up

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Cost minimization

answer

firms choose production method that produces any given level of output at lowest possible cost

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Technical efficiency

answer

least capital and labour to produce the same output

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Condition of cost minimization

answer

MPK/PK = MPL/PL

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3 sections of long run average cost curve (LRAC)

answer

1. economics of scale / increasing returns to scale (IRS)
2. constant returns to scale (CRS)
3. diseconomies of scale / decreasing returns to scale (DRS)

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Economies of scale

answer

cost of production (L & K) increases, but output rises by a lot more, so cost/unit falls
as you increase scale of production, the gain is larger; labour and capital are more efficient

question

Constant returns to scale

answer

cost of production (L & K) increases, and output increases by exact same amount, so cost/unit constant

question

Diseconomies of scale

answer

cost of production (L & K) increases, but output rises by a little bit, so cost/unit rises
managerial difficulties where labour and capital are no longer efficient

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Points below LRAC curve

answer

unattainable; LRAC is lowest cost ever possible

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Planning horizon

answer

long term; depending on which level of output you plan to produce, you can choose the best SATC

question

Minimum efficient scale

answer

lowest level of output at which a firm can minimize long-run average costs

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LRAC curve

answer

envelope of all SATC curves; minimum ever cost; tangential to lowest cost arms of each SATC (falling arms, min of 1 SATC, and rising arms)

question

Long-run marginal cost (LMC) curve

answer

intersects LRAC at its minimum (because marginal drives the average - same as short-run)

question

Relationship between SMC and LMC

answer

at point where STAC tangents with LRAC, SMC will intersect LMC; before, SMC < LMC, after SMC > LMC
(in order for SRAC>LRAC before minimum, SMC must be < LMC, and same for after minimum)

question

Technological improvement shift to LRAC

answer

downward

question

3 categories of technological change

answer

1. new techniques
2. improved inputs
3. new products

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Principle of substitution

answer

methods of production will change if relative prices of inputs change, with relatively more of cheaper and less of more expensive input being used

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Productivity

answer

output produced per some unit of input

question

Why no AVC, AFC, ATC in long-run?

answer

all costs are variable in long-run

1 of 184

question

Economics

answer

study of the use of scarce resources to satisfy unlimited human wants

question

3 factors of production

answer

land, labour, capital

question

Capital

answer

produced means for further production

question

Opportunity cost

answer

value of the next best alternative that is forgone when one alternative is chosen

question

Production possibility boundary

answer

maximum combination of production given your labour endowment

question

Productive efficiency

answer

using the least possible resources

question

Allocative efficiency

answer

using resources where they are most highly valued

question

2 reasons for PPB to shift out

answer

more producers, more efficiency

question

Economic growth

answer

improvement of the PPB (shifts out), due to more resources or technological improvements

question

4 key economic problems

answer

1. What is produced and how (production)
2. What is consumed and by whom (consumer behaviour)
3. Why are resources sometimes idle
4. Is productive capacity growing

question

Microeconomics

answer

study of causes & consequences of allocation of resources as it is affected by the workings of the price system

question

Macroeconomics

answer

study of the determination of economic aggregates such as total output, employment, and growth

question

Producer and consumer behaviours

answer

1. self-interested
2. profit/utility/satisfaction-maximizing
3. rational

question

Invisible hand

answer

term economists use to describe the self-regulating nature of the marketplace; set of prices

question

How is spontaneous, natural order generated?

answer

producers/consumers responding to price in their best interests

question

Two ways government is involved in free market

answer

1. provision of property rights
2. freedom of contract

question

Two ways government enforces their roles

answer

1. police
2. court of law

question

Marginal

answer

refers to the last unit

question

Market failure

answer

market fails to generate an efficient outcome, and government may need to intervene; total surplus not maximized

question

3 reasons for government to intervene in a market

answer

1. inefficiently allocated resources
2. providing public goods
3. achieving equity / mitigation of purchasing power to remediate unfair distribution of commodities

question

Globalization

answer

increased importance of international trade

question

2 things globalization is enabled by

answer

1. revolution in information technology
2. rapid reduction in transportation costs

question

Challenges of globalization

answer

1. human rights
2. environmental
3. production standards
4. global sellers have lower costs than local sellers

question

Two ways to increase local production

answer

tax and quotas on imports

question

3 types of economic systems

answer

1. traditional
2. command/centrally-planned
3. free market

question

Traditional economy

answer

production is only what they need, but economic/social mobility very limited

question

Command economy

answer

dictatorship or centrally-planned economy; no incentive to get more efficient, and unable to raise living standards

question

Free market economy

answer

constantly competing and gaining efficiency

question

Karl Marx

answer

question

Normative statement

answer

depends on value judgements; what should happen

question

Positive statement

answer

matter of fact; can be false though

question

Theory

answer

generalization of an observation; abstraction from reality

question

3 things theory is based on

answer

1. variables
2. assumptions
3. predictions

question

Variables

answer

well-defined items that can take on different values

question

Assumptions

answer

1. motives (e.g. maximize satisfaction/profits)
2. direction of causation
3. conditions of application (e.g. government is irrelevant for the theory)

question

Model

answer

formal presentation of a theory

question

Function

answer

x = f(Px) where direction of causation is Px->x

question

How to test a theory

answer

confront the predictions with evidence

question

Endogenous variable

answer

value is determined within a theory

question

Exogenous variable

answer

variable outside the theory that affects the variables in the theory - e.g. income

question

Index

answer

measure of some variable conventionally expressed relative to a base period, which is assigned value 100

question

Value of index in given period

answer

= (absolute value in given period / absolute value in base period) x 100

question

Consumer Price Index (CPI)

answer

representation of average level of prices in economy; used to calculate rate of inflation

question

Two forms of data

answer

1. time series
2. cross-section

question

Demand

answer

desire backed by purchasing power and willingness to pay

question

6 factors affecting demand

answer

1. own price
2. income
3. price of related goods
4. consumers' tastes
5. population changes
6. significant changes in weather

question

Direction of causation for demand

answer

price -> quantity, ceteris paribus (negatively related)

question

Ceteris paribus

answer

all other things remaining constant

question

Law of demand; relation of own price (1) to demand

answer

when price rises, quantity demanded falls; when price falls, quantity demanded rises; other things remaining constant

question

Relation of income (2) to demand

answer

normal goods: positive
inferior goods: negative

question

Relation of price of related goods (3) to demand

answer

substitutes: positive
complements: negative

question

Relation of tastes (4) to demand

answer

positive

question

Relation of population (5) to demand

answer

positive

question

When price changes...

answer

move along the demand curve; change in quantity demanded

question

When any variable other than price changes...

answer

shift in the demand curve (e.g. increased income shifts the demand curve rightward)

question

Change in demand

answer

change in quantity demanded at every price

question

Change in quantity demanded

answer

movement between points along the demand curve

question

Supply curve direction of causality

answer

price -> quantity, positively related

question

Minimum reservation price

answer

cost of production the producer incurs for a certain quantity produced; all the points on the supply curve

question

6 factors affecting supply

answer

1. price of inputs
2. technology
3. government taxes or subsidies
4. prices of other products
5. significant changes in weather
6. number of suppliers

question

Relation of price of inputs (1) to supply

answer

negative - increased price of inputs shifts leftward (higher cost of production)

question

Relation of technology (2) to supply

answer

positive - increased technology increases production efficiency, shifts rightward (lower cost of production)

question

Relation of taxes and subsidies (3) to supply

answer

taxes: negative
subsidies: positive

question

Relation of prices of other products (4) to supply

answer

substitutes: negative (will switch to the more profitable substitute)
complements: positive (if one is profitable, so will the other)

question

Equilibrium point

answer

the point at which quantity supplied equals quantity demanded; no excess of either, no upward/downward pressure

question

Derivation of market demand/supply curve

answer

horizontal summation of individual demand/supply curves; as you have more individuals (and population rises), curve flattens out (and shifts right)

question

Combinations of demand and supply curve shifts

answer

1. D right, S right -> P (?), Q increase
2. D right, S left -> P increase, Q (?)
3. D left, S right -> P decrease, Q (?)
4. D left, S left -> P (?), Q decrease

question

3 types of market linkages (shift equally in same direction)

answer

1. substitutes
2. input-output
3. joint-production (by-product)

question

Elasticity

answer

the degree to which quantity demanded/supplied would change as a result of change in price; flexibility, responsiveness

question

Elasticity formula

answer

= % change in quantity demanded / % change in price

question

Calculating elasticity over an arc

answer

= ((QA-QB)/Qavg) / ((PA-PB)/Pavg)

question

Calculating point elasticity

answer

= (PA/QA)/slope of D curve

question

Elasticity = 0

answer

perfectly/infinitely inelastic; vertical demand curve (demand does not respond to price)

question

0 < elasticity < 1

answer

inelastic

question

Elasticity = 1

answer

unit elastic

question

Elasticity > 1

answer

elastic

question

Elasticity = infinity

answer

perfectly/infinitely elastic; horizontal demand curve (no change in price)

question

3 determinants of elasticity of demand

answer

question

Total expenditure (TE)

answer

= P x Q

question

TE if elastic

answer

increases

question

TE at midpoint

answer

same

question

TE if inelastic

answer

decreases

question

Total revenue for producer

answer

= total expenditure for consumer

question

TE graph

answer

negative parabola

question

Marginal revenue (MR)

answer

= change in TR / change in Q

question

MR for elastic

answer

positive

question

MR for unit elasticity

answer

question

MR for inelastic

answer

negative

question

Cross-price elasticity of demand

answer

= % change in quantity demanded of X / % change in price of Y

question

Cross-price elasticity of demand for substitutes

answer

positive

question

Cross-price elasticity of demand for complements

answer

negative

question

Income elasticity of demand

answer

= % change in quantity demanded / % change in income

question

Income elasticity of demand for normal goods

answer

positive

question

Income elasticity of demand for inferior goods

answer

negative

question

Two types of normal goods

answer

necessities and luxuries

question

Income elasticity of demand for necessities

answer

0 < elasticity < 1

question

Income elasticity of demand for luxuries

answer

elasticity > 1

question

2 determinants of elasticity of supply

answer

1. ease of substitution (greater ease = more elastic)
2. short-run and long-run (long-run = more elastic)

question

Excise tax

answer

a tax on the sale of a particular product; raises price paid by consumer and reduces price received by producer

question

Direct vs. Indirect taxes

answer

Direct: you have to pay (e.g. income tax)
Indirect: burden can be shifted to consumer; impact and incidence on different individuals

question

What determines burden of excise tax on producer and consumer?

answer

relative elasticities of supply and demand

question

More elastic demand effect on excise tax

answer

producers pay larger share

question

More elastic supply effect on excise tax

answer

consumers pay larger share

question

When two demand curves intersect at a positive quantity...

answer

curve with flatter slope is more elastic

question

When two demand curves with different slopes have same price-axis intercept...

answer

curves have same elasticity

question

When two demand curves have same slope but different intercepts...

answer

outside curve is more elastic (demand increases with no change in slope)

question

When two demand curves with different slopes do not intersect at any price...

answer

outside curve is less elastic

question

Price floor

answer

minimum permissible price charged for a good or service; above the equilibrium price, excess supply

question

Example of price floor

answer

minimum wage => unemployment (excess supply)

question

Price ceiling

answer

maximum price that can be charged for a good or service

question

Example of price ceiling

answer

rent control => excess demand, limited supply

question

Q exchanged in disequilibrium

answer

minimum of Q demanded and Q supplied

question

Black market

answer

products sold at prices violating legal price control; seller will buy at price ceiling, but sell at buyer's price, and make a profit

question

3 goals of price ceilings

answer

1. restrict production
2. keep specific prices down
3. satisfy notions of equity in consumption of product temporarily in short supply

question

3 effects of rent controls

answer

1. shortage of rental housing because demand > supply
2. alternative allocation scheme - landlords are picky
3. hidden (black) markets appear

question

Rent control in short- and long-run

answer

short-run: inelastic (can't adjust)
long-run: landlords won't invest anymore

question

Winners and losers in rent control

answer

winners: current tenants
losers: future tenants, landlords

question

Quotas

answer

quantity controls; e.g. supply of maple syrup is too high, so prices would be driven down, but if quota is low, we can charge buyer's price and make profit

question

Diminishing marginal utility

answer

Decreasing satisfaction or usefulness as additional units of a product are acquired

question

Total economic surplus

answer

area below demand curve and above supply curve; consumer's surplus + producer's surplus

question

Where is total surplus/welfare maximized?

answer

equilibrium; market efficiency

question

Consumer's surplus (CS)

answer

the difference between the maximum price a buyer is willing and able to pay and the price actually paid; area under the demand curve, above price paid, bounded to the right by quantity demanded

question

Producer's surplus (PS)

answer

question

Deadweight loss (DWL)

answer

reduction in total surplus that occurs as a result of a market inefficiency

question

Government surplus

answer

portion of total economic surplus going to government in excise taxes

question

Utility

answer

satisfaction that a consumer receives from consuming some good or service

question

Marginal utility

answer

additional satisfaction obtained from consuming one additional unit of a product; different for each unit

question

3 assumptions of diminishing marginal utility

answer

1. commodity must be provided in small and regular units of time
2. commodity must be in a sizeable unit
3. cases of increasing marginal utility are exceptions

question

Condition for a consumer to maximize utility

answer

MUx/Px = MUy/Py

question

2 effects of a price change

answer

1. alters relative price (substitution effect)
2. alters consumer's real income (income effect)

question

What determines slope of demand curve?

answer

size of total effect

question

Real income

answer

the purchasing power of nominal income

question

Substitution effect

answer

price of one good decreases while the other is constant, causing relative decrease in price, so quantity demanded increases

question

Income effect

answer

price of one good decreases with income constant, but purchasing power of income increases, so quantity demanded increases

question

2 characteristics of Giffen goods

answer

1. inferior good, where decreased real income will increase purchasing power
2. takes large portion of total household expenditure => large income effect which offsets substitution effect

question

Conspicuous goods

answer

goods consumed for "snob appeal"; some consumers will buy more if the price goes up, but most others in economy will still buy less (net negatively sloped demand curve)

question

Paradox of value

answer

apparent contradiction between the high value of a nonessential item and the low value of an essential item

question

2 important aspects of determination of price ignored by the paradox of value

answer

1. supply is just as important as demand in determination of price
2. consumers purchase units of a good until marginal value of last unit purchased is equal to its market price

question

Solution to paradox of value

answer

water has high total value; high CS, and low marginal value
diamond has low total value; low CS, high marginal value

question

Effect of price change; normal goods

answer

income and substitution effects in same direction

question

Effect of price change; inferior goods

answer

income effect partially offsets substitution effect

question

Effect of price change; Giffen goods

answer

income effect outweighs substitution effect

question

Formation of market demand curve

answer

horizontal summation of individual demand curves

question

6 organizations of firms

answer

1. single proprietorship
2. ordinary partnership
3. limited partnership (general & limited)
4. corporation (private & public)
5. state-owned enterprise
6. non-profit organization

question

2 assumptions for all firms

answer

1. single decision-making unit
2. profit-maximizing

question

4 types of inputs for production

answer

1. outputs from other firms (intermediate products)
2. nature
3. services of labour
4. services of physical capital

question

Production function

answer

Q = f(K,L) where K = capital, L = labour; shows maximum output that can be produced by a combination of inputs

question

Explicit cost

answer

cost associated with a transaction that actually happened

question

Accounting profit

answer

= revenue - explicit costs

question

Economic profit

answer

= revenue - (explicit + implicit costs)

question

Implicit costs

answer

opportunity costs

question

Short run

answer

time period in which quantity of some input is fixed

question

Long run

answer

time period in which all factors of production can change, but technology is fixed

question

Very long run

answer

time period in which all factors of production and technology can change

question

Average product (AP)

answer

= total product (TP) / quantity of labour (L)

question

Marginal product of labour (MP)

answer

= change in TP / change in L

question

Diminishing marginal product of labour

answer

principle that if at least one input of production is fixed (capital), the marginal productivity of additional variable resources (labour) will eventually fall and contribute less and less to output

question

MP and AP relationship

answer

Marginal drives the average!
When MP > AP, each additional worker increases output; both curves rise
When MP < AP, each additional worker decreases output; both curves fall
MP cuts AP at its max

question

Total cost (TC)

answer

= total fixed costs (TFC) + total variable costs (TVC)

question

Average total cost (ATC)

answer

= TC/Q = AFC + AVC

question

Marginal cost (MC)

answer

= change in TC / change in Q = change in TVC / change in Q

question

Where does MC cut AVC curve

answer

minimum

question

Capacity

answer

level of output corresponding to minimum of SATC curve; largest output that can be produced with increasing average cost per unit

question

Rise in price of variable factor (wage) effect on SATC

answer

TVC, TC, AVC, ATC, MC shift up

question

Rise in price of a fixed factor (capital) effect on SATC

answer

TFC, AFC shift up (MC same)

question

Rise in quantity of a fixed factor (capital) effect on SATC

answer

TFC, AFC shift up, MC, AVC shift down; usually becomes more productive, so AP and MP shift up

question

Cost minimization

answer

firms choose production method that produces any given level of output at lowest possible cost

question

Technical efficiency

answer

least capital and labour to produce the same output

question

Condition of cost minimization

answer

MPK/PK = MPL/PL

question

3 sections of long run average cost curve (LRAC)

answer

1. economics of scale / increasing returns to scale (IRS)
2. constant returns to scale (CRS)
3. diseconomies of scale / decreasing returns to scale (DRS)

question

Economies of scale

answer

cost of production (L & K) increases, but output rises by a lot more, so cost/unit falls
as you increase scale of production, the gain is larger; labour and capital are more efficient

question

Constant returns to scale

answer

cost of production (L & K) increases, and output increases by exact same amount, so cost/unit constant

question

Diseconomies of scale

answer

cost of production (L & K) increases, but output rises by a little bit, so cost/unit rises
managerial difficulties where labour and capital are no longer efficient

question

Points below LRAC curve

answer

unattainable; LRAC is lowest cost ever possible

question

Planning horizon

answer

long term; depending on which level of output you plan to produce, you can choose the best SATC

question

Minimum efficient scale

answer

lowest level of output at which a firm can minimize long-run average costs

question

LRAC curve

answer

envelope of all SATC curves; minimum ever cost; tangential to lowest cost arms of each SATC (falling arms, min of 1 SATC, and rising arms)

question

Long-run marginal cost (LMC) curve

answer

intersects LRAC at its minimum (because marginal drives the average - same as short-run)

question

Relationship between SMC and LMC

answer

at point where STAC tangents with LRAC, SMC will intersect LMC; before, SMC < LMC, after SMC > LMC
(in order for SRAC>LRAC before minimum, SMC must be < LMC, and same for after minimum)

question

Technological improvement shift to LRAC

answer

downward

question

3 categories of technological change

answer

1. new techniques
2. improved inputs
3. new products

question

Principle of substitution

answer

methods of production will change if relative prices of inputs change, with relatively more of cheaper and less of more expensive input being used

question

Productivity

answer

output produced per some unit of input

question

Why no AVC, AFC, ATC in long-run?

answer

all costs are variable in long-run

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ECON 208 Midterm

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