Econ 2110 (Chen Wang) Final Exam Study Guide PDF

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Notes for final for Econ 2110 ...

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Econ 2110 (Chen Wang) Test 4 Study Guide -

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Lecture 1 o Scarcity = all goods are scare goods  Does not necessarily mean they are rare but something (MC) must be up to acquire the good o Tradeoffs are everywhere – because of scarcity, we do not have sufficient resources to do everything o Incentives Matter – these are rewards and penalties that motivate behavior based on each individuals’ preference - As tradeoffs change, peoples preferences change o Thinking at the margin – because of tradeoffs people make their decisions “at the margin” = “with 1 additional one” or “depending on the situation” o People compare the Marginal Benefits and the Marginal Costs o The time cost of something is what you must give up AT THE MARGIN to get it not just the price of the thing, but is also includes the next best opportunity that you give up! o Tradeoffs make people better off – so trading in a market, consumers receive consumers’ surplus and producers receive producers’ surplus o If a trade took place, it benefited both the consumers and producers o The possibility of trade allows for SPECIALIZATION Lecture 2 o Marginal Principle: MB > Mc o Bob and Pizza Slice 1 2 3 4 5 6 Total $8 $14 $15 $15.50 $15.55 $14.55 Benefits MB $8 $6 $1 $.50 $.05 -$1 o MB = Bob’s willingness to pay for each slice of pizza and if pizza is $2.50 a slice (this is also the MC), then Bob will only buy two slices of pizza because MB>MC, but if Bob is at an “all you can eat place” then the MB=0, so Bob will eat 5 slices. Lecture 3 o Opportunities Cost = the value of the next best alternative and the directly associated cost of the primarily option o OC = MC o Sunk Cost = past cost and since they already happened, it will not affect your future choices o Only cost AT THE MARGIN matter! Lecture 4 o Gains from trade = when a good moves from the seller with lower valuation to the buyer with high valuation  The difference between these two valuations is the GAINS FROM TRADE or TOTAL SURPLUS o Trade allows for specialization (this is based on the comparative advantage)

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o Absolute Advantage = can produce the good using fewer resources o Comparative Advantage = can produce the good at the lower Marginal Cost Lecture 5 o Find out who has the comparative advantage for a product – they specialize o Between two people, only 1 can have the comparative for 1 product and the other person will have the comparative advantage in the other product Lecture 6 o Demand is based on consumers’ willingness to pay aka how much a good is valued o Depends on the MB the consumers’ get from consuming the good o Demand is represented as a relationship between price and quantity demanded o Demand is a set of prices and quantities that indicate the number of units that need to be purchased at any given price o Demand schedule o Demand Curve o Demand Function o Quantity demanded = the quantity of goods consumers are willing to boy at the given price o The relationships between price and quantity demanded along a demand curve is always negative o Law of Demand: when price goes up, quantity demanded goes down, vice versa o Substitute: what you buy if the price of a good goes up – everything has substitutes Lecture 7 o Producers will only be willing to supply a good, if they can receive more than their MC for it – “supply’ represents producers MC o Suppliers will be willing to increase quantities supplied only if they can get a higher price for the good in order to compensate for the increasing MC supply curve (relationship between price and quantity supplied) is always positive o Law of Supply: when price goes up, quantity supplied goes up, vice versa Lecture 8 o If market price is above/below, the equilibrium spot, then quantity demanded does not equal supplied o In a free market with no restrictions, the market should go to the equilibrium and this is where price and quantity are at the equilibrium o At the equilibrium, the equilibrium price = price consumers pay = price producers receive = equilibrium quantity = quantity demanded = quantity supplied o The price of any good adjusts to bring the quantities of that good supplied and demanded into balance o Automatic movement towards the equilibrium – we use the word ‘equilibrium” because at this point price/quantity pairs/ demand = supply Lecture 9 o If the market price is in equilibrium, why do prices change? Because of demand/supply shift

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demand increase both equilibrium quantity and price increase

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demand decreases both equilibrium quantity and price decrease

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Factors that shift demand  Taste  Income – if income increases then, demand will increase for normal goods and demand will decrease for inferior goods  Price of Related Goods – substitutes and complements  Size of the market  Expectation of prices

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Supply increases equilibrium quantity increases and price decreases

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supply decreases equilibrium quantity decreases and price increase

Factors that shift demand  The price of the inputs  technology  Size of the market  Expectation of prices Lecture 11 o Three steps for figuring the effect of an event on equilibrium price and quantity  1. Decide whether supply, demand, or both have shifted  2. Decide in which directions the shift occurred  3. Use the supply and demand diagram to see how the shift affect the equilibrium pf price and quantity  if both supply and demand shift, then whichever one has a greater shift will determine the outcome o if both supply and demanded shift, the outcome depends upon which is greater – change in supply or change in demand o if both supply and demand shift, shift the demand curve first while holding supply constant. After the demand shift, shift the supply curve while o

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holding demand constant. Then check the impact on the equilibrium price and quantity o If Demand increases and Supply increases  Demand increases = price increases and quantity increases  Supply increases = price decreases and quantity increases  Equilibrium quantity increases  Equilibrium price depends o If Demand increases and Supply decreases  Demand increases = price increases and quantity increases  Supply decreases = price increases and quantity decreases  Equilibrium price increases  Equilibrium quantity depends o If Demand decreases and Supply decreases  Demand decreases = price decreases and quantity decreases  Supply decreases = price increases and quantity decreases  Equilibrium price depends  Equilibrium quantity falls o If Demand decreases and Supply increases  Demand decreases = price decreases and quantity decreases  Supply decreases = price increases and quantity decreases  Equilibrium price falls  Equilibrium quantity depends Lecture 12 o Price elasticity: a measure of the responsiveness of quantity to changes in price o Elasticity measures  How much more consumption/less production we get when price falls  How much less consumption/more production we get when prices rise o If demand is elastic even a small increase in price will be enough to inspire many buyers to switch to substitutes; and a small drop in price is enough to attract many additional buyers to buy this good o If demand is inelastic, many buyers will go on buying even if there is a large increase in price and even if there is a big drop in price, there might only be a few additional buyers buying this good. o If supply is elastic, even a small price increase may be enough to inspire many sellers to increase quantity supplied substantially o If supply is inelastic even a large increase in price may not generate much additional quantity supplied o The closer substitutes a good has, or the closer the substitutes of a good are the more elastic the demand for this good is. o If cost rises very fast then the supply is inelastic o If the cost rises more slowly then the supply is elastic o If demand/supply is more elastic, then demand/supply curve is flatter. If more inelastic, then steeper. o Demand and supply are more elastic in long run and more inelastic in the short run. Measuring Elasticity

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Measured in percent change

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Elastic demand has nothing to do with supply and elastic supply has nothing to do with demand. If demand of a good is perfectly inelastic, then Elastic demand = 0, and it means this is good has absolutely no substitutes This situation is impossible because everything has substitutes. Ever necessities. They are irreplaceable, but there are always different brands of them, such as different brands of water and insulin. If demand is perfectly elastic, E demand = - ∞ and it means this good has

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many perfect substitutes and if demand and if the price of this good has many perfect substitutes and if the price of this good foes up even by a penny, no one would buy any. Possible, but very unlikely. Perfectly elastic supply implies that quantity supplied can be expanded without raising MC – possible but unlikely  Horizontal line on graph o Perfectly inelastic supply implies there would be no increase in quantity supplied regardless of the size of the increase in price  Usually happens in the short run  Vertical line on graph Lecture 13 o Another way of calculating elasticity  Elastic demand = (slope of demand function) x (price/ quantity demanded)  Use this formula when you are given the demand function  Use this formula when you are given old price and quantity demanded and new price and quantity demanded o Elasticity of demand and revenue:  Total revenue: TR = P x Q  If price rises, TR may increase or decrease. Because of the law od demand, if prices rise, quantity demanded goes down. Therefore, TR will increase when rises rise if demand is inelastic and decrease if demand is elastic. o Demand is Elastic is |E D|>¿ 1  The percent change in quantity is larger than the percent change in price  Consumers are “price sensitive” o Demand is Inelastic is |E D| quantity supplied  Therefore, price celling reduces gains from trade and creates a shortage  BUT… it also redistributes the surplus  a price celling must be biding to have an effect o If the mandated minimum is greater than the equilibrium price, the mandate has no affect  Also since the market quantity is less than equilibrium quantity, there will be a reduction in the total surplus, which we call “deadweight loss” o This represents mutually beneficial trades that are not consummated  E can see some surplus is transferred from producers to consumers after the price ceiling is applied  A binding price ceiling must be BELOW the equilibrium price. If a price ceiling is above the equilibrium price, it was NO effect at all.  Price floor: a legislated minimum price  examples; ag supports, minimum wage  if the controlled price is greater than the equilibrium price, a surplus occurs o

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When there is a price floor, the quantity demanded at the price floor is the market quantity Also at the price floor, quantity supplied > quantity demanded. Therefore, there is a surplus in the market. The size of the surplus is quantity supplied – quantity demanded This ‘surplus’ means extra units of good produced. Do not confuse this with the surplus in consumers surplus A binding price floor must be ABOVE the equilibrium price. If the price floor is below the equilibrium price, it has NO effect at all.

Lecture 16 o Overview of taxes  Taxes are the main means of raising funds of different government programs  But they also create a deadweight loss by reducing gains from trade  Also taxes are used to discourage what are perceived as harmful activities (ex: smoking) o A tax can reduce both supply and demand therefore, when there is a tax market quantity is less than equilibrium quantity and DWL is generated where there is a tax, market quantity = quantity demand = quantity supplied < equilibrium quantity o How do we model taxes using supply and demand?  A tax on producers decreases supply – higher tax on an object means it cost more to produce that product so less of that product would be produced  A tax on consumers decreases demand – higher tax on an object would means it cost more to buy it so there would be less desire for that product o The greater the unit tax, the higher the price consumers pay and the lower the price producer receive and the lower the market quantity, the greater the deadweight loss o If your good is to raise tax revenue, you want to tax something inelastically supplied and demanded. Otherwise, the market quantity would see a great decrease which means there is not many goods left to tax o If your good is to reduce quantity, you must make sure demand is not too inelastic for a price rise to much effect o This is related to elasticity, you need to keep in mind the things that might affect elasticity. o It doesn’t matter who us being taxed, consumers or producers, the outcome would be ABSOLUTTELY THE SAME. The tax burden would be shared by both parties. Which party pays more depends on ELASTICITY o If demand is more elastic than supply, then producers pay more tax than consumers and vice versa o Subsidy  A subsidy can increase both supply and demand  Therefore, when there is subsidy, market quantity is greater than equilibrium, and DWL is generated  When there is subsidy, market quantity = quantity demand = quantity supplied > equilibrium quantity

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When there is a subsidy, the piece consumers pay is less than the price producers receive

Lecture 17 o Externalities  Negative externality: the ‘doer’ does not bear the full cost of the action  Positive externality: the ‘doer’ does not bear the full benefit the action  When there are costs or benefits that are not taken into account, market outcomes fail to maximize surplus o Externalities and Efficiency  When there are externalities, the market outcome will be inefficient (there will be a deadweight loss).  Negative externality: because some of the costs aren’t being counted, too much of the good is produced  Positive externality: because some of the benefits aren’t being counted, too little of the good is produced o When there is negative externality, then TOO MUCH of the good is being produced o When there is a positive externality, then TOO LESS of the good is being produced o When there is externality, too much or too little of a good is being produced, which implies the market is not at the equilibrium, therefore there is DWL and the market price does not reflect the time cost of production Lecture 18 o To resolve externalities, we too clearly define property/ownership o Another way to apply regulation or taxation  For example, because negative externalities involve costs not taken into account, too much product is being produced or too much action is taken, so we can impose tax to reduce the market quantity o Externalities are particular problem with goods that you cannot stop from being used – non-excludable goods o Public goods: non-excludable goods for which one person’s uses does not reduce the mount left for another  Example: national security, police protection, fire departments, charity, public highways o Consumers resource: a non-excludable, they will not be used efficiently. Free rider problem will emerge when it comes to these goods  Free rider: a person who receives the benefit of a good without for it...