Final – Study Guide - Anne Duchene PDF

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Emilie Kern Final Review Sheet

Econ 001 Final Review 14 MC + 3 SA (1: externalities, 2: labor, 3: other) *Evaluate = efficiency + equity *DWL = between two Qs (the efficient Q and the production Q), between MC and MB *C.S. = area under demand curve and above the price *P.S. = the area between the price and the marginal cost curve (MC) P.S. = Revenue – TVC (area under the curve) Midterm 1 Opportunity Cost ● → highest valued forgone alternative ● All actions imply opportunity costs ● Opportunity Costs = True Economic Costs ● The inverse of the slope of the opportunity cost of whatever is on the horizontal axis is the opportunity cost of what is on the vertical axis ● O.C. = accounting cost + max value alternative ○ → (max. value alternative = benefit - cost) ● viewing O.C. as time (ex. 2⁄3 of time for cookies + 1⁄3 for scarves) ● Constant opportunity costs → straight line graphs ● Increasing opportunity costs → curved graphs

Example: Library + study for econ test: value at $12 Movie: costs $5, values at $30 Lunch: costs $10, values at $55 O.C. of lunch = 10 + 25 = $35 *can either get $12 or $25 – chooses $25 because is max. value alt. *do not include value of $55 of chosen option (lunch) Example: Nonrefundable ticket for $150 to Florida Train tickets to NY = $50, benefit of $250

O.C. = 250 – 50 = $200 (ignore sunk cost of plane ticket) Economics → the study of the allocation of scarce resources to satisfy unlimited wants ● For this definition to hold there must be on resource with a constraint (binding) Sunk Cost

● → a cost that has already been incurred and thus cannot be recovered ○ Ex. non-refundable plane ticket that was already purchased 1 ● Value of something that you can get for it ○ Non refundable plane ticket - $0 = no value – ignore it if it has no value Production Possibilities Frontier (PPF) ● → a graph showing the maximal different combinations of output for a given amount of input ● assumption: must have constraint on resource in at least one dimension ● Shows what can be produced efficiently, inefficiently, and what can’t be produced ○ Efficiency = no waste ■ Production efficiency → all available resources are utilized, using all resources on the PPF ○ Allocatively Efficient ■ → producing all the right combinations of what you want, preferences; greatest possible benefit ○ Any point inside the PPF is a point where we are wasting resources, any point on the PPF is a point of efficiency, and any point outside the PPF is unattainable ○ Inefficient ■ If the point is inside the PPF, the opportunity cost of that point is zero (0) ■ So, if you are inefficient, the O.C. is equal to 0 ■ Production is inefficient inside the PPF because resources are either unused or misallocated or both ● The slope of the PPF is the opportunity cost of the good on the horizontal axis in terms of the good on the y-axis ● Curved PPF → a curved PPF demonstrated that the opportunity cost of what is on the horizontal axis is increasing Economic Growth → increase in the production of goods and services; shifts the PPF out ● Due to technological improvement or investment in capital goods Consumption Possibility Frontier ● consumption possibilities frontier/trade line = allows to consume more than produce, can be outside PPF → straight line ● Cannot be inside the PPF, but also cannot be too far outside the PPF ● The consumption possibility frontier should be tangent to our point on the PPF because it is

attainable Joint PPFs ● Want the person to do the thing they are better at → more efficient ● If two people, then one kink, if three people, then two kinks etc. ● To determine who goes out on the market first, we should look at opportunity costs (the lower opportunity cost goes first) ● Absolute Advantage ○ → a person has an absolute advantage if they can produce more per unit of input (e.g. time) or who is more productive than someone else 2 ● Comparative Advantage ○ → a person or nation has a comparative advantage in an activity if they can perform an activity at a lower opportunity cost than others ○ If the person is relatively more efficient in one thing and has a lower opportunity cost, they therefore have a comparative advantage ○ Principle of comparative advantage → specialize good with the lowest opportunity cost of production = specialization ■ Specialization requires exchange ○ Specialization and trade according to comparative advantage increases consumption ● Sell at a price that is higher than cost of production, buy at a price that is lower than cost of production → therefore the price of the good will be btwn. the two opportunity costs ● Trading leads to increased production because it permits specialization Example of PPF and Joint PPF: Home Goods Market Goods Sarah 5 10 Abe 2 8

Joint PPF ● point D = both spending time at home – Abe is splitting time → slope = O.C. of Abe ● point E = Sarah splitting time → slope = O.C. of Sarah ● point C = full specialization, Sarah making home goods and Abe making market goods ● Price of market good should be btwn. O.C.’s

3 Supply and Demand ● Demand Curve ○ → shows the quantity of a good that buyers wish to buy at each price, all other influences remain the same ○ There is a negative relationship between price and quantity demanded....so the demand curve has a negative slope ○ Can also look at the demand curve as a willingness and ability to pay curve ■ The willingness and ability to pay is a measure of marginal benefit ● Reasons the Demand Curve Shifts Out (For Demand to Increase) or Shift In (Demand Decrease) ○ 1. Income Increase ■ Shifts out for a normal good (steak) ■ Shifts in for an inferior good (ramen noodles) ○ 2. Price of Another Good Increases ■ Shifts out for a substitute (orange juice for lemonade) ■ Shifts in for a compliment (pb + j) ○ 3. Population increase ■ Shifts out ○ 4. Taste ■ Shifts out and Shifts in ■ Change in taste used to explain an umbrella of categories ■ Preferences or taste determine the value that people place on each good and service

○ 5. Expectations of Future Price ■ A change in expectations so you can buy the good now and store it ■ So buy more of the good now, shift out of demand curve ■ Or if price is supposed to be cheaper in future, demand decreases now and increases later ● Supply Curve ○ → a schedule or curve showing the quantity of a good that sellers wish to sell at each price, all other influences remain the same ○ There is a positive relationship between price and quantity supplied... so the supply curve has a positive slope ○ At higher prices, sellers are willing to sell more units ■ A higher price covers higher opportunity costs of production ○ Why does a higher price increase the quantity supplied? ■ → because marginal cost increases ■ If a small quantity is produced, the lowest price at which someone is willing to sell one more unit is lower (because marginal cost is lower here aka opportunity cost is low here) ● But as quantity produced increases, the price at which someone is willing to sell one more unit is higher because marginal cost has now increased aka opportunity cost is higher 4 ● Reasons the Supply Curve Shifts in (Decrease in Supply) or Shift out (Increase in Supply) ○ 1. Weather Change ■ Shifts in or Shifts out ○ 2. Exit or Entrance by Firms ■ Shifts in or Shifts out ○ 3. Technological Deterioration ■ Shifts in ○ 4. Technological Improvement ■ Shifts out ○ 5. Changes in prices of other goods (that the firm can produce) ■ Shifts in or Shifts out ○ 6. Prices of Factors of Production ■ aka an ingredient in something in order to produce it ● Ex. Milk for milk powder ■ Shifts in or shifts out ● Equilibrium Price and Quantity

○ → the price and quantity for which quantity demanded = quantity supplied ○ Market Equilibrium ■ → occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price ● Excess Supply/ Market Surplus ○ A situation in which the quantity supplied is greater than the quantity demanded ○ Qs > QD ○ Unemployment – too many people looking for labor ● Excess Demand/ Market Shortage ○ A situation in which quantity demanded is larger than quantity supplied ○ QD > Qs ○ New Iphone, nikes ○ A shortage can only arise when there is no equilibrium because something is blocking the good from reaching a new equilibrium ● Invisible Hand ○ Alleviates excess supply ■ → leads to the price falling ○ Alleviates excess demand ■ → leads to the price rising and we reach a new equilibrium where quantity supplied = quantity demanded ● Movement Along the Supply and Demand Curves ○ Change in quantity demanded is a movement along a demand curve ■ Whereas a change in demand is a shift of the demand curve ■ The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price ● The term quantity demanded refers to a point on a demand curve – the quantity demanded at a particular price 5 ■ If the price of the good changes but no other influence on buying plans change, we illustrate the effect as a movement along the demand curve ○ Change in quantity supplied is a movement along a supply curve ■ Whereas a change in supply is a shift of the supply curve ■ The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a given price Elasticity ● Price Elasticity of Demand ○ → price elasticity of demand is the responsiveness of the quantity demanded to a change in price ● Equation for Elasticity: ○ Price Elasticity can range from 0 to ∞

■ Elastic Demand = price elasticity of demand > 1 ■ Inelastic Demand = price elasticity < 1 ■ Unit Elastic Demand - price elasticity of demand = 1 ○ For small changes in price ■ Price Elasticity = or at a point = ∆P/P

)( ) (

Q

P1

∆Q/Q

slope

■ As we go down the demand curve, elasticity of demand decreases ● Total Revenue ○ → the total amount of funds received by a seller of a good or service, TR =(P)(Q) ○ If demand is elastic and we lower the price → total revenue increases ○ If demand is inelastic and we lower the price → total revenue decreases ○ If demand is unit elastic and we lower the price → total revenue remains constant (unchanged) ● What Elasticity of Demand Depends On ○ availability of close substitutes (more substitutes → more elastic demand curve) ○ time elapsed since a price change ○ luxuries vs. necessities 6 ● Cross Price Elasticity of Demand ■ Cross Price Elasticity = %∆ in Price

%∆ Quantity

of Substitute

Demanded

or complement

○ Cross price elasticity > 0 → the two goods are substitutes (positive) ○ Cross price elasticity < 0 → the two goods are complements (negative) ● Income Elasticity of Demand ■ Income Elasticity = %∆ Quantity demanded %∆ in income

○ → A measure of the responsiveness of quantity demanded to changes in income ■ Income elasticity > 0 → normal good ■ Income elasticity < 0 → inferior good ● Elasticity of Supply ○ → price elasticity of supply is the responsiveness of the quantity supplied to a change in price ○ Elasticity of Supply = ∆ Q/Q ∆ P/P = ( P/Q)(1/slope) ● What Elasticity of Supply Depends On

○ Input substitution ■ Can the supplier change their behavior ● If yes → elastic .... If no → inelastic ○ The time frame for supply decisions ● Maximize revenue where demand is unit elastic Efficiency and Equity ● Pareto Efficiency ○ → is it possible to make one person better off without making someone else worse off?

○ If you can make a pareto improvement, then the prior allocation of resources is inefficient....but if efficient cannot do a pareto improvement ● Maximizing Total Welfare → maximizing happiness in society ● Marginal Benefit (Demand Curve) ○ → is the benefit a person receives from consuming one or more unit of a good or service, the pleasure of having an extra unit ● Marginal Cost (Supply Curve) ○ → the marginal cost of a good or service is the opportunity cost of producing one more unit of it ● Consumer Surplus ○ → the value of a good (marginal benefit) minus the price paid, summer over the quantity bought (area below the demand curve and above the equilibrium price) ● Producer Surplus ○ → the price of a good minus the marginal cost of producing it, summed over the quantity sold (area above the supply curve and underneath the equilibrium price) 7

Government Intervention: Taxes ● Dead Weight Loss – a measure of inefficiency, equals the decrease in total surplus that results from an inefficient level of production ● Tax Incidence – division of the burden of a tax between the buyer and the seller, who suffers when a tax is imposed, depends on elasticity of supply and demand ○ Full tax incidence falls on consumers when demand is perfectly inelastic ○ Full tax incidence falls on the producers when demand is perfectly elastic

○ ● Total Surplus → Total Surplus = consumer + producer surplus ○ Total surplus is maximized at at equilibrium quantity, where MC = MB

● Perfectly inelastic supply or demand results in no DWL ● The greater the elasticity of supply and demand, greater DWL ● subsidy = negative tax; Pd + s = Ps; causes overproduction and DWL (→ use efficiency and equity to evaluate policies) ○ Apply to P (ex. P + 3) and then set Q’s equal

○ Shift out of supply

8 ● When calculating total surplus when a tax is imposed, we have to take into account consumers, producers, and the government ● The more inelastic the demand, the larger the consumers’ share of the tax ● Perfectly inelastic supply → sellers pay entire tax ● The more elastic the supply, the larger the consumers’ share of the tax ● Price Ceiling – cannot go above set price (by the government) ○ we will have excess demand (shortage) + creation of total surplus, DWL ● Price Floor – cannot go below set price (minimum wage = floor on labor market) Midterm 1 MC’s: 4. In April, pop artists perform more frequently than during any other month. They also earn the highest pay for their concerts in April. What could explain both of these phenomena? – D – many colleges host “Spring Flings” in April and book pop artists to perform at these shows 5. The Rave, the theater on 40th & Walnut Street, sells movie tickets at a discount of $5 on Tuesdays. In evaluating that policy, the Rave finds that their revenue from movie tickets decreases on Tuesdays, but that the discount may still be worthwhile because it encourages customers to buy more concessions. What can the Rave conclude about the market for movie tickets? – B – demand for movie tickets is inelastic 7. In the United States marriage rates increase with income. In other words, richer people are more likely to marry. Which of the following statements describe this phenomenon? – B – income elasticity of marriage is positive and marriage is a normal good 8. Philadelphia recently passed a tax of 1.5 cents per ounce on soda beverages to raise revenue for education. Assuming normal supply and demand curves, what can we expect to occur in the Philadelphia soda market? – C – I and III I. The price of soda will rise II. Soda producers will earn more revenue due to higher soda prices III. Consumers will purchase less soda 9. Which of the following statements is correct? - Both I. All else equal, the more inelastic the demand is the more of the tax burden will fall on the consumer. II. All else equal, the more inelastic the supply is the more of the tax burden will fall on the seller.

Midterm 2

1. Firm Goal: Profit Maximization ● profits = revenue – cost = (P*Q) – TC ● total product: total output produced in a given period

9 ● marginal product: change in total product that results from one-unit increase in quantity of labor employed, with all other inputs remaining ● Law of Diminishing Returns – as a firm uses more of a variable input, with a given quantity of fixed inputs, the marginal product of the variable input eventually diminishes (marginal product of an additional workers is less than the marginal product of the previous worker) → the task cannot be broken into more steps for specialization ■ This is why MC eventually increases ○ short-run relationship – fixed inputs ○ virtual relationship is different ● widget production function (TP) ○ starts at (0,0) – without labor, there is no output ○ positive, increasing function ○ graph of slope → marginal productivity (negative slope but positive) ● total cost: cost of all resources used (TC = TFC + TVC (*all as function of Q)) ● total fixed cost: cost of firm’s fixed inputs ● total variable cost: cost of firm’s variable inputs (labor) ● average fixed cost (AFC) = TFC/Q ● average variable cost (AVC) = TVC/Q ● average total cost (ATC) = TC/Q = AFC + AVC ● marginal cost (MC): increase in total cost that results from a one-unit increase in total product (first goes down, then up when hits law of diminishing returns) ○ Calculated by % change in TC / % change in output ○ intersects averages at average minimums ● Causes for cost decrease: change in technology → increase output for given input → all curves shift down, cost of inputs decrease

*if VC changes → change in all 3 curves *if FC changes → ATC changes *if tech change → change in all 3 curves Shifts: up + left or down + right

2. Perfect Competition ● standardized product (homogeneous product) ● many buyers and sellers ● no barriers to new firms entering market ● full information 10 ● perfectly competitive market → no industry supplier has significant influence on price of product → firms are price takers ● goal: maximize profit (π =revenue – cost) by choosing quantity ○ two methods to find optimal output: calculate profit at every possible point or set MC=MR=P → find q* P=MC ○ note: max profit ≠ positive economic profit ○ → Economic loss when costs > revenue ○ → π > 0 if P > ATC (at q*)

● supply curve of perfectly competitive firm = MC curve ○ short-run: MC curve above min. AVC ■ at least one factor of production is fixed ○ long-run: MC curve above min. ATC ■ quantities of all factors of production can be varied ○ shutdown point = minimum point on the firm’s AVC curve; if price falls below this point, the firm shuts down production in short run ○ if fixed costs are greater than losses then you are better off producing and losing some profit than not producing anything at all

○ short run supply = Q = N•q 3. Perfect Competition: The Long Run ● free entry: firms enter industry in which existing firms earn economic profit ● free exit: firms exit industry in which they incur economic loss ● long run profits: go to zero ● Demand curve is completely elastic for individual firms ● Q* = sum of all “q”s in market = # of firms in industry (n) * q* 11 ● No reason to enter when profits = 0, and profits = 0 when P = ATC ○ Firms stop entering when price falls equal to ATC ○ No incentive to enter Q at min ATC ● Rule of profit maximization: P = MR = MC ● Rule of long run zero profits: P = ATC, in the long run firms will produce at min ATC ○ price = ATC (and MC=ATC): profits = zero → firms stop entering ● when P = MC, if P is less than AVC → should stop production ● take derivative of TC to get MC ● Exit = long run decision

12 4. Monopoly: The Basics ● Characteristics of a monopoly: ○ 1 firm ○ product is differentiated ○ there are barriers to entry (ex. legal/patent, cost) ○ firms are price setters (vs. price takers in perfectly competitive market, P does not have to equal MR here) ○ consumers determine quantity (given a price) ● profit maximization: MC = MR but Price > MR ○ A monopoly sets quantity such that MC = MR < P ● marginal revenue = ∆(Total Revenue) ○ if quantity changes (ex. from 100 to 99) then price changes (ex. from 50 to 51) → revenue changes ● Price > MR

○ Calculus Example: Revenue = P*Q= (150-Q)(Q)=1500-Q^2 ○ → MR = derivative of Revenue = 150 – 2Q < 150 – Q ○ → MR has double the slope of Demand curve ● Monopoly faces same types of technology constraints as the competitive firm. ● Monopoly faces different market constraint. (because a firm is a price setter, we know MR < P) ● Graphing profit maximization of ...