Business 115 EXAM Revision PDF

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BUSINESS 115 EXAM REVISIONQUESTION MODULES Exam Topic Focus Areas 1 5 Price elasticity of demand (definition; formulas and calculations; factors influencing elasticity; relationship between total revenue and elasticity along a linear demand curve). 2 6 Macroeconomic measures (nominal versus real GDP...

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BUSINESS 115 EXAM REVISION QUESTION 1

MODULES 5

Exam Topic Focus Areas Price elasticity of demand (definition; formulas and calculations; factors influencing elasticity; relationship between total revenue and elasticity along a linear demand curve).

2

6

Macroeconomic measures (nominal versus real GDP; basics of price indices; measurement biases; pros and cons of rising versus falling prices over time).

3

7&9

Monetary system and monetary policy (basic monetary system concepts; expansionary versus contractionary monetary policy using the OCR and transmission effects).

4

8&9

Fiscal policy and open-economy macroeconomics (expansionary versus contractionary fiscal policy; crowding out/in; applications of the 3-panel openeconomy macro model).

5

2,3&4

Law and regulation (key case/s looked at during the Commercial Law modules and the application of the Commerce Act 1986 with respect to market power and regulation).

Module 5: Price Elasticity and Its Application

1. Identify key factors affecting the price elasticity of demand (supply). 2. Calculate numerically and show diagrammatically the price elasticity of demand (supply). 3. Calculate numerically the cross-price elasticity of demand and income elasticity of demand. 4. Use the price elasticity of demand to describe how the burden of a tax is shared (i.e., tax incidence). 5. Differentiate between and assess the effects of a price (rent) ceiling and price (wage) floor. 6. Evaluate a negative production externality and propose a suitable remedy.

How to calculate price elasticity?

Definition of Elasticity: Elasticity is the degree of responsiveness of one variable to changes in another

Price Elasticity of Demand: Is the percentage change in quantity demanded that results from a 1% change in its price. %change in quantity / %change in price

Elastic/Inelastic Demand: Elastic Demand is where a price change results in a comparatively large change in quantity, i.e., when Price Elasticity of Demand > 1 Inelastic Demand is where a price change results in a comparatively small change in quantity, i.e., when Price Elasticity of Demand < 1

Elasticity and Total Revenue: Total revenue is the amount paid by buyers and received by sellers of a good. Total Revenue = Price * Quantity

If demand is inelastic, then an increase in price leads to higher revenue. This is because with inelastic demand, the proportional fall in quantity with an increase in price is smaller than the increase in price.

If demand is elastic, then an increase in price leads to lower revenue. This is because with elastic demand, the proportional fall in quantity with an increase in price is larger than the increase in price.

Determinants of Elasticity: Substitution possibilities: with many similar goods, if price of one good goes up, can easily switch to a substitute. Budget share: if a good only makes up a small share of budget, an increase in price is less likely to change purchasing decision. Time: can take time to adapt, so the price elasticity of demand for any good or service will be higher in the long run than in the short run.

Perfectly Elastic Demand: Where a slight increase in price causes consumers to switch to substitutes

Perfectly Inelastic Demand: Consumers cannot switch to substitutes regardless of price. Consumers need the good regardless of the price.

Cross-price Elasticity:

Cross-price Elasticity:

Price Elasticity of Supply: Measures the responsiveness of the quantity supplied to a change in price = % change in quantity supplied / % change in price

Perfectly Inelastic Supply:

Inelastic Supply:

Elastic Supply:

Determinants of Elasticity: Flexibility of inputs: increasing production requires increasing inputs, so elasticity of supply greater if inputs are flexible, mobile or easily substitutable. Time: can take time to build new factories, hire new workers, etc., so the price elasticity of supply will be higher in the long run than in the short run.

Who bears the burden of a tax? Impact of a Tax: Suppose a per-unit tax on sellers. The demand-supply equilibrium before the tax.

New supply curve: Suppose a $3 tax per unit. After the tax, suppliers will require $3 more to supply any given quantity. A tax shifts the supply curve up by the amount of tax. Equilibrium after Tax:

Impact on Prices: Price paid by consumers increases by $2 Sellers receive $1 less So, $2 of the $3 tax is passed on to the consumers.

Tax Incidence: How much tax is passed on to consumers (through changes in price) depends on how badly they want the good compared to how badly producers want to sell the good. If demand is more elastic than supply, then producers pay most of the tax. If supply is more elastic than demand, then consumers pay most of the tax. Examples: Elastic Supply, Inelastic Demand.

Inelastic Supply, Elastic Demand.

Government Revenue: How much revenue does the government earn as a result of the tax? Total tax revenue = quantity * Tax (per unit) Using the quantity of the new equilibrium.

Deadweight Loss:

A sales tax in a competitive market causes a loss to society, the deadweight loss. This is because when the equilibrium price increases, some buyers and sellers who would have liked to trade are squeezed out of the market.

Surplus before tax:

After tax:

Deadweight loss: The size of the deadweight loss depends on demand and supply elasticities. If either demand of supply is very inelastic, the deadweight loss will be small. This is because if the market is inelastic, the quantity traded won’t change much as most buyers and sellers will continue to trade. If demand or supply is perfectly inelastic, a tax will result in no deadweight loss, because the quantity sold in the market will not change.

Does a minimum wage hike mean fewer jobs?

Price controls Price controls hold market prices above or below the competitive equilibrium price. A price ceiling is a maximum price that producers can charge: e.g., Rent controls, maximum increase in tuition fees, generally to help the consumer. A price floor is a minimum price that consumers must pay: e.g., Agricultural goods, minimum wage, generally to help the consumer.

A non-binding price ceiling:

A binding price ceiling:

Responses to shortages: Queues, Rationing, Black market (at higher than legal prices)

A non-binding price floor:

A binding price floor:

Responses to surplus: Dumping, dumping to other countries, Black market (at lower than legal prices)

Minimum wage:

An important example of a price floor is the minimum wage. The minimum wage is the lowest price an employer may legally pay a worker. Minimum wage in NZ NZ was the first country to introduce legislation to determine minimum wage – Industrial Conciliation and Arbitration Act 1894. Current Minimum Wage Act 1983: Minimum wage must be reviewed by government each year. Was 2.50 in 1984, increase to $20 this year.

Minimum wage laws and level of minimum wage vary a lot across countries. In France, the government decides the minimum each year, taking into account increase in average wage, but must increase by at least as much as inflation. In USA, new legislation must be passed to change minimum wage.

Labour Market after minimum wage:

Minimum wage and elasticity:

In a competitive labour market, a minimum wage will increase wages for wages for workers who can find a job --- however may increase unemployment. The resulting increase in unemployment depends on the elasticity of labour demand.

Empirical studies disagree on the effect of minimum wages on unemployment (some even find a decrease ion unemployment) but mostly small increase or no effect. May depend on: Different elasticities of labour demand Non-competitive labour markets (employers have “market power” and set wage below the competitive equilibrium) Statistical problems in identifying “casual effect”

Module 6: Macroeconomic Concepts

1. Define gross domestic product (GDP) and distinguish between nominal and real national income. 2. Describe some limitations of GDP; some limitations of GDP as a measure of economic welfare. 3. Calculate basic measures of national income and the cost of living. 4. Calculate and interpret the income growth rate, the inflation rate, and the real interest rate. 5. Explain some limitations of CPI as a measure of the cost of living.

How to measure national income?

Definition of Macroeconomics: The study of the economy as a while. Its goal is to explain the economic changes that affect many households, firms and markets at once. As the economy is a collection of many households and firms, microeconomics and macroeconomics are closely linked. Interested in fiscal and monetary policies that influence economic growth and national wellbeing. Measuring A Nation’s Income When Judging whether the economy is doing well or poorly , it is natural to look at the total income that everyone in the economy is earning. Every transaction has a buyer and a seller and every dollar of spending by some buyer is a dollar of income for some seller, for an economy as a whole, income must equal expenditure, Gross Domestic Product (GDP) is a measure of the income and expenditures of an economy. The income-expenditure identity can be illustrated with the circular-flow diagram.

Definition of Gross domestic product: GDP is the market value of all final goods and services produced within a country in a given time period. “market value” – adds together many different types of products using market prices to create a common unit of account for each good. “of all final goods and services” – includes all items produced and sold legally in markets. And only the final value.

“produced” – only includes goods currently produced, doesn’t include used goods. “within a country” – only includes items produced domestically. “given time period” – measures the value of production that takes place within a specific interval of time, usually a year or a quarter. GDP can be divided into four main components

GDP = consumption + investment + government purchases + net exports. Consumption: spending by households on goods and services, not including housing. Investment: purchases of goods (capital equipment, structures, inventory, household purchases of new houses) that will be used in the future to produce other goods and services. Government purchases: spending by local and central governments, includes salaries to government officials Net exports: The purchases of domestically produced goods by foreigners less the domestic purchases of foreign goods. Net exports = exports – imports.

Definition of Gross National Income (GNI): Refers to the total income earned by a nation’s permanent residents GNI differs from GDP in the way that it includes the income that residents of the country earn and excludes income that foreign nationals earn in the country. GNI = GDP + Net factor income from abroad (NFIA)

Definition of Gross National Disposable Income (GNDI): GNI plus net transfers from the rest of the world. Transfers are payments made that are not in exchange for any currently produced goods or services. GNDI = GNI + net current transfers (NCT) Examples: A retired New Zealand resident receives income from a pension fund in the UK, NCT increases. New Zealand pays aid to the Solomon Islands, NCT decreases. GNDI provides the best measure of the income at a nation’s disposal for spending or savings.

How to measure the cost of living?

Definition of Consumer Price Index: A measure of the overall cost of the goods and services purchased by a typical household. The CPI indicates how much incomes must rise to maintain a constant standard of living.

Definition of General Price Level: The price of a bundle of goods and services measured as an index relative to a base period. Most usually CPI or some variation of it is used.

Definition of Inflation: The percentage increase in the general price level over a given period of time. Inflation occurs when the price level rises over time. The inflation rate is the % change in the price level relative to the previous period.

Procedure of Calculating the CPI Inflation In New Zealand, the CPI includes prices for over 700 goods and services. The procedure of calculating the CPI is as follows. 1. Fixing the Basket: Include goods and services that a typical consumer buys and weight these goods and services according to how much consumers buy of each item. 2. Find the prices: Record the prices of goods and services for each point in time from representative grocers and retailers. 3. Compare the cost of basket: Use the data on prices to calculate the cost of the basket of goods and services at different times. 4. Choose a base period and compute the index: Choose a base period against which the price level is compared in all other periods are compared and compute the index as: CPI = * 1000

5. Calculate the CPI inflation rate:

Use the index to calculate the consumer price inflation rate as: Inflation Rate in Year 2 (%) = X 100

The Typical Basket of goods in New Zealand: The CPI Basket:

Definition of The Food Price Index: The price of food and food services purchased by households. Calculated monthly Definition of The Producers price Index (PPI): The prices in the production sector of the economy. Provides an indication of input prices for firms and useful for predicting changes in the CPI.\

Difficulties in Measuring the Cost of Living 1. Substitution bias 2. Introduction of new goods

3. Unmeasured quality changes

Substitution bias: Changes in relative prices induce consumers to substitute towards goods that have become relatively expensive. However, the items in the CPI basket and their quantity are fixed, independent of consumer reaction to changes in relative prices. This means the index can overstate the rise in the cost of living by not considering consumer substitution. Example: the price of tea increases, the quantity in the CPI basket remains the same, however in reality consumers purchase more of coffee because it’s now cheaper. Introduction of New Goods: New products result in greater variety, which in turn makes each dollar more valuable. Consumers need fewer dollars to maintain any given standard of living. The basket does not reflect the change in purchasing power brought on by the introduction of new products. This means the index overstates the increase in cost of living by not considering the introduction of new goods. Unmeasured Quality Improvement: If the quality of a good rises from one year to the next, the value of a dollar rises, even if the price of the good stays the same. If the quality of a good falls from one year to the next, the value of the dollar falls, even if the price of the good stays the same. Statistic New Zealand tries to adjust the price for constant quality, but such differences are hard to measure. This means the index overstates the increase in cost of living by not considering unmeasured quality improvements and it understates the increase in cost of living by not considering unmeasured quality reductions.

Revisions to the Basket: The CPI revisions look at new items which may need to be included, new weights and sometimes whether the CPI needs to be re-based. Module 7: Macroeconomic Theories: The Economy in the Long Run

1. List key determinants of economic growth and justify why some countries grow faster than others. 2. Describe what is meant by unemployment and its natural rate. 3. Define some concepts of the monetary system and explain two approaches to money creation. 4. Examine the classical theory of inflation and the Fisher effect.

Macroeconomics Concept Map: Production and Growth

Production and growth Productivity refers to the amount of goods and services that a worker can produce from each hour of work. Productivity plates a key role in determined living standards for all nations in the world. To understand the large differences in living standards across countries, must focus on the production of goods and services.

How productivity is determined: The inputs used to produce goods and services are called the factors of production. The factors of production directly determine productivity.

The factors of production: Physical Capital

Human capital Natural resources Technological knowledge

Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of outputs from production. Y = A F(L, K, H, N) Y = quantity of output A = available production technology L = quantity of labor K = quantity of physical capital H = quantity of human capital N = quantity of natural resources F() is a function that shows how the inputs are combined A production function has “constant returns to scale” Meaning if you change all of the inputs L, K, H, N The Y will change by the same percentage.

Unemployment and its Natural Rate

How is unemployment measured? Unemployment is measured by Statistics New Zealand The data comes from a regular survey of about 30000 individuals, called the Household Labour Force Survey. Based on the survey answers, adults (>=15 yrs) are categorised into either Employed, Unemployed or Not in the labour force (student, homemaker, retiree). The labour force is the total number of workers, sum of employed and unemployed. The unemployment rate is calculated as the percentage of the labour force that is unemployed. Unemployed / Labour Force. Labour-force participation rate: The percentage of the adult population that is in the labour force.

Labour force / Adult population

Why are there always some people unemployed? In an ideal labour market, wages would adjust to balance the supply and demand for labour, ensuring that all workers would be fully employed. Frictional unemployment or Search unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. Results from the labour force searching for their job. There is always an amount of unemployment because of this reason. This type of unemployment is not caused by a wage rate higher than equilibrium. It’s also caused by sectoral shifts.

Structural unemployment is the unemployment that results because the number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one.

Short run economic fluctuations Economic activity fluctuates from year to year. In most years production of goods and services rises. In some years, the economy experiences a contraction rather than growth, causing a recession. A recession is a period of declining real incomes, and rising unemployment. A depression is a severe recession.

Changes in real GDP are inversely related to changes in the unemployment rate. During times or recession, unemployment rises substantially. Most economists believe that classical theory describes the world in the long run but not in the short run. Changes in the money supply affect nominal variables but not real variables in the long run. The assumption of monetary neutrality is not appropriate when studying year to year changes in the economy.

The Monetary System

Money is the set of assets in an economy that people regularly use to buy goods and services from other people. Money has three functions in the economy: Medium of exchange Unit ...