Microeconomics MIDTERM exam Study Guide Chapter 1-11 PDF

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Midterm Study guide chapter 1-11, concepts, definitions, graphs, examples for concepts. ...

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CHAPTER 1: TEN PRINCIPLES OF ECONOMICS ● economics is the study of how a society manages its scarce resources ● fundamental lessons about individual decision making ○ people face trade-offs among alternative goals ○ decisions are made by comparing costs and marginal benefits ○ ppl change bx in response to incentives ● fundamental lessons about interactions among ppl ○ trade and interdependence can be mutually beneficial ○ gov’t can improve market outcomes ● fundamental lessons abt the economy as a whole ○ productivity is the ultimate source of living standards ○ growth in the quantity of money → inflation ○ Society faces a short-run trade-off btwn inflation and unemployment ● 10 principles ○ how people make decisions ■ People face trade-offs ● I.e.: choosing btwn going to the cinema or working ■ Cost of smtn is what you give up to get it ● i.e.: during the time you were studying, attending classing you could have earned money working ■ Rational ppl think at the margin ● I.e.: when a firm decides whether to produce an extra unit of some good, it will always look at the cost   of producing 1 extra unit vs. the benefit ■ Ppl respond to incentives ● I.e.: gov’t imposes a higher tax on cigarettes → ppl would stop smoking ○ how people interact ■ Trade can make everyone better off ● people specialize in the things they are good at so that they can trade with one another ● absolute advantage: ability to produce a good using fewer inputs than another producer ● comparative advantage: ability to produce a good at a lower opportunity cost than another producer ● gains from trade are based on comparative advantage because both parties will benefit when they specialize in smt where both will consume more goods and reach points outside the ppf ● graph: people face trade-offs btwn certain goods b/c their budget is limited so only the points inside and on the production possibility frontier are attainable however with trade, people will specialize and obtain points outside the curve.

● the producer who has the comparative advantage determines who specializes in what product and when this takes place, total production in the economy rises → making everybody better off ■ Markets are usually a good way to organize economic activity ■ Gov’ts can sometimes improve market outcomes ● laws → to stimulate economic activity ● Property rights: the ability of an individual to own and exercise control over scarce resources ○ I.e.: singer wouldn’t produce any music if she knew everybody could get an illegal copy of her music ○ How the economy as a whole works: ■ A country’s std of living depends on its ability to produce goods + services ● big diff btwn annual incomes for countries around the world ● I.e.: we can make a lot more w/ 1 unit of labour in Germany vs. Nigeria ■ Prices rise when the gov’t prints too much money ■ Society faces a short-run trade-off btwn inflation and unemployment ● Increasing the amt of money stimulates overall spending thus, demand for goods+ services → higher demand may cause firms to raise prices but, also → hire more workers → produce more goods +services = more hiring means lower unemployment

CHAPTER 2: THINKING LIKE AN ECONOMIST ● circular-flow chart: reps the organization of an economy; decisions are made by households and firms → ○ they interact in the markets for goods and services → households are buyers and firms are sellers ○ they also interact in the markets for the factors of production → firms are buyers and households are sellers

● production possibilities curve: shows combo of output (capital+consumer goods) that the economoy can possibly produce. economy can produce anything on (points C, A) or inside the curve (B) but it’s considered inefficient since we have the resources to produce more → maybe this is due to widespread unemployment; points outside the curve (D) are unattainable given the economy’s resources but, w/ an increase in technological progress → it can shift the ppf curve upwards → we can produce according to D. ● Microeconomics: study of decisionmaking by households and the interaction among household and firms in the marketplace ● Macroeconomics: the forces and trends that affect the economy as a whole ● normative statement: claims that attempt to describe how the world ought to be; economists as policy advisers ○ I.e.: gov’t should raise the minimum wage ● positive statement: an assertion abt how the world is ○ I.e.: minimum-wage laws cause unemployment ● Key difference: how we judge their validity → we can confirm or refute positive statements by examining evidence vs. normative statement involve our view on ethics, religion, political philosophy

CHAPTER 3: THE MARKET FORCES OF SUPPLY AND DEMAND ● supply a nd demand → forces that make market economies work ○ buyers determine demand ○ sellers determine supply ○ demand curve is downward sloping and supply curve is upward sloping ● market: group of buyers and sellers of a particular good or service ● competitive market: many buyers and sellers, each has a negligible impact on the market ○ i.e: ice-cream market → sellers do not charge more/less b/c customers can easily find the same ice cream elsewhere ○ perfectly competitive market characteristics: ■ goods offered for sale are exactly the same ■ many buyers and sellers such that no party has any influence on the price ● i.e: wheat market ● monopoly: 1 seller, and seller controls price

● oligopoly: few sellers→ not always aggressive competition ● quantity demanded: ○ change determined by factors such as income, prices of related goods, tastes, expectations and the number of buyers ■ a change in the price of the product → movement along the demand curve ■ a shift in the demand curve ← a factor other than a change in the price ● i.e: s uppose new research says ice-cream makes you live longer → demand for ice-cream will increase → demand curve would shift  to the right ● i.e: research suggests ice-cream is bad for your health → demand decreases → demand curve shifts to the left→ at any given price, you purchase less than before ■ consumer income: ● as income increases the demand for a normal good will  increase ● as income increases the demand for an inferior good will decrease ○ i.e: bus ride ■ price of related goods: ● substitutes: a fall in the price of one good reduces the demand for another good ○ i.e: if the cost for frozen yogurt falls, the law of demand says you will buy more frozen yogurt → now, you will reduce your spending on ice-cream since both goods are similar ○ i.e: hotdogs + hamburgers; movie tickets + DVDs ● complementary goods: a fall in the price of one good increases the demand for another good ○ i.e:  DVD and a DVD-player ● quantity supplied: change is determined by a change in anything that alters the quantity supplied at each price ○ a rise in the price → movement along the supply curve ○ change in a determinant other than the price → a shift to the left or right ■ decrease in supply → left  price of sugar rises → producing ice cream is less ● i.e: i nput prices → profitable → supply less ice-cream  if ben and jerry's retired from the ice-cream business, ● i.e: number of sellers → the supply of the market would fall ● i.e: expectation : if a firm expects the price of ice-cream to rise in the future → store its current product → sell in the future ■ increase in supply → shift to the right ● i.e: t echnology → less labour necessary to make ice-cream→ reduce firm’s costs → raise the supply

● equilibrium price : price that balances quantity supplied and quantity demanded ● equilibrium quantity: quantity supplied and quantity demanded at the equilibrium price ● surplus: price > equilibrium price → quantity supplied > quantity demanded ○ suppliers will lower prices to increase sales and move toward equilibrium ● shortage: price 1 → elastic  →  quantity demanded does respond strongly to price changes ○ Price elasticity of demand < 1 → inelastic   → quantity demanded doesn’t respond ” ○ Price elasticity of demand = 1 → unit elasticity→ changes in price = quantity total revenue: the amount paid by buyers and received by sellers of a good ○ Computed as the price of the good times the quantity sold : TR = P x Q ○ inelastic demand curves: TR moves in the same direction as the price ○ elastic demand curves: TR moves in the opposite direction as the price income elasticity of demand: measures how much the Q demanded for a good changes when income changes by a certain percentage

○ i.e: ● Types of goods: ○ Normal goods: goods whose demand rise when consumers’ income rises ■ i.e: L  CD tv, organic food, branded clothes ○ Inferior goods: goods whose demand decline when consumers’ income rises ■ i.e: c anned vegetables, ramen, use of public transportation ● Price elasticity of supply: measures the change in quantity supplied after a change in price

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■ i.e:

CHAPTER 5: BACKGROUND TO D  EMAND: THE THEORY OF CONSUMER CHOICE ● “one is seeking to maximize their utility subject to the constraint of a limited income” ● standard economic model (SEM): AKA classical theory of consumer behaviour model that assumes rational behaviour → humans behave rationally when making consumption choices ○ people face trade-offs in their role as consumers ■ when making these trade-offs, assumptions abt consumers → ● buyers are rational ● more is preferred to less ● buyers seek to maximize their utility ● c onsumers act in self-interest and do not consider the utility of others ● utility : the satisfaction derived from the consumption of a product ○ ranking→ ordinal concept → can be used to rep consumer choices in some order ○ the amt buyers are prepared to to buy a good tells us smt abt the value   they place on it ■ willingness to buy p rinciple → i.e.: cheetah shoes for $75: J o thinks they’re worth buying while Mel would never pay a dime for such kinda shoes ■ it’s not just the amt of $$$ we hand over that reflects value  but what that money could’ve bought ○ opportunity costs: what was given up to make a purchase → i.e.: Mel believed she could’ve allocated that $75 to get more/better value → the alternative that money could buy repped greater value ● budget constraint: what the consumer can afford ○ ppl consume less than they desire b/c their spending is constrained by their income ■ i.e.: ppl usually want to take longer, fancier holidays but they consume less than desired b/c they’re limited by their income ○ graph: b udget constraint shows the various combo of goods (trade-off btwn 2 goods) the consumer can afford given his/her income + prices of the 2 goods ■ the slope of the budget constraint line measures the rate at which a consumer is willing to trade one good for another

● slope: RISE/RUN ■ shifting of the budget constraint: a change in income ● rise in income →  shift to the right ○ i.e.: →   shift to the ● fall in income → left ■ change in price of one good → budget constraint will pivot on the axis of the good that does not change in price ● indifference curve: shows the consumption bundles that yield the SAME utility ○ if a consumer chooses one good over another → that good provides more utility than the other good ○ if two goods provide the same level of utility → consumer is indifferent btwn them ○ by seeing which points are on the higher indifference curve, we can use the set of indifference curves to rank any combo of the two items ○ marginal rate of substitution: s lope ; rate at which a consumer is willing to trade one good for another ■ it’s not linear→ MRS changes from point to point. rationale behind it is that if you have a lot of coke, you’re willing to give up some coke for a pizza and vice versa ○ 4 properties of indifference curves (has to satisfy these 4 conditions): ■ higher indifference curves are preferred to lower ones ● higher indif. curves rep larger quantities of goods → consumers prefer more vs. less thus, consumers prefer to be on higher indiff curves ■ they’re downward sloping ● if the quantity of one good is reduced, the quantity of the other good must increase in order for the consumer to remain equally happy ■ they do NOT cross ■ they’re bowed inward ● perfect substitutes: 2 goods w/ straight-line indifference curves; MRS is a fixed number  MRS would be fixed→ 2 ○ i.e.: nickels and dimes →

● perfect complements: 2 goods w/ right-angle indifference curves  you only care abt pairs so your happiness would be the same if ○ i.e.: left and right shoes → you had 7 left and 5 right shoes ● Optimization:  w  hat the consumer chooses ○ consumer wants to attain the highest indif. curve b/c he’s the happiest there but he also faces a budget constraint so he cannot buy unlimited amts of goods ○ point where the budget constraint is tangent to the indif. curve: point where a consumer’s utility is maximized given the budget constraint → utility maximization ○ if income rises, the budget constraint shifts to the right → we are able to attain a point on a higher indif. curve ■ when income rises, consumers buy more of normal goods ■ when income rises, consumers buy less of inferior goods i.e.: potatoes ○ price change → i.e.: suppose the price of Pepsi drops from $2 to $1/ pint. Consumer can now buy 1000 pints vs. 500 → new budget constraint rotates and has a steeper slope ○ price change has 2 effects on consumption → ■ income effect: consumer can reach a higher indif. curve → c onsume more pizza and pepsi b/c you’re richer ■ substitution effect: consumer moves along an indif. curve w/ a new, diff MRS→ consume more pepsi b/c it’s cheaper ● demand curves can sometimes slope  upward ○ when a consumer buys more of a good when its price rises ○ giffen goods: goods for which an increase in the price increases the quantity demanded ■ they’re pretty rare ● Behavioural approaches to consumer bx: ○ bounded rationality: idea that humans make decisions under the constraints of limited and unreliable info ■ ppl are overconfident ■ give too much weight to a small number of observations ■ are reluctant to change their minds ■ have a tendency to look for examples which confirm their existing view ■ consumers use r ules of thumb, common sense → heuristics

■ anchoring: using familiarity to make decisions; a cognitive bias that influences you to rely too heavily on the first piece of info you receive → J CPenney thought it was a smart move to eliminate coupons and instead create “everyday low pricing.” Too bad they weren’t aware of the power of the anchoring effect. When sales slid big time, they got the message. They’ve now reversed their policy and customers are returning. We need that anchor number to inform us that we’re getting a bargain.; ● i.e.2: I f a husband is doing ten times more housework than his dad ever did, he may feel entitled to a “best husband of the year” award from his wife. Imagine his surprise then, when his wife berates him for not doing enough. What’s going on here? Blame it on the anchoring effect. His anchor is what his dad used to do. Her anchor is the amount of housework she does. ■ availability: when assessing relative risk/danger, a mental shortcut that makes fast, but incorrect, judgments→ w  hat is the most dangerous job? high profile police shootings might lead you to think that cops have the most dangerous jobs ■ representativeness: decisions made based on how representative smtn is to a stereotype→ a person accused of abducting a child for ransom may be more likely to be viewed as guilty as someone accused of kidnapping an adult for no ransom. While both crimes represent kidnapping, the first is a more representative example because it fits better with what most people think of when they hear the word "kidnapping." ■ persuasion: attributes  a consumer attaches to a product or brand → ‘bandwagon’  effect – if a large number of people go and see a movie and rave about it on FB then there is even more incentive for others to go and see it as well. Firms may look to try and create a bandwagon effect to utilize this persuasion heuristic in their marketing. ■ simulation: visualizing  or simulating an outcome of smt → pharmaceutical firms know that consumers are more likely to buy and take medicine that deal with known and experienced symptoms (headaches, strained muscles, sore throats and runny noses) which are easy to visualize and imagine than taking regular medicine for smt like high cholesterol because it is hard to build a mental process for the effects of high cholesterol

 OMPETITIVE CHAPTER 6: BACKGROUND TO S  UPPLY: FIRMS IN C MARKETS ● goal of firms is to maximize profit → p rofit = total revenue - total cost ○ total revenue: amt  of money a firm receives for selling its products → ■ TR = PRICE x QUANTITY → 100 balls for $5 each = $500 ○ total cost: sum of explicit and implicit costs ● cost of production: includes all the opportunity costs of output of goods/services ○ explicit costs: out of pocket costs for a firm ■ i.e.: wages a firm pays its workers, materials, rent

○ implicit costs: input costs that don’t require an outlay of money by the firm ■ i.e.: wages the firm owner gives up by working in the firm rather than taking another job; avoiding rent by using the ground floor of a home for business ○ economic profit takes both explicit and implicit costs into account whereas accounting profits doesn’t consider implicit cost such as opportunity costs ● time periods: fixed  and variable costs → in the short run, some costs are fixed, i n the long run, fixed costs become variable costs ● marginal product of labour: amt of extra output when you hire 1 more worker ○ i.e.:  amt of pizzas extra produced if you hire 1 more worker ● production function: shows the relationship btwn labor units (horizontal axis) and the total product on the vertical axis → i.e.:  Quantity of workers on the X axis and Quantity of pizzas on Y axis

● diminishing marginal product: marg. product of an input declines as the Q of the input increases ○ i.e.: as more and more workers are hired, each additional worker yields less and less production b/c the firm has a lmtd amt of equipment ○ graph: initially the slope is quite steep, but it declines as you hire more workers→ marginal product declines and the production function becomes flatter ● total cost curve: shows the relationship btwn the Q a firm can produce and its costs ● different kinds of costs related to production: ○ fixed costs: costs which do not depend on the number of goods you produce ■ i.e.:  cookie factory → you pay rent every month, rent is a fixed cost→ it doesn’t depend on the amt of cookies produced ○ variable costs: costs that do d epend on the number of goods produced ■ i.e.:  flour needed to produce cookies → more cookies you produce, the more flour you’ll need ● total costs:

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○ Total Fixed Costs (TFC) ○ Total Variable Costs (TVC) ○ TC = TFC + TVC average costs: ○ ATC = TC / Q ■ average total-cost curve is U-shaped ● in beginning, ATC is high bc fixed costs are divided among just a few units ● if more goods are produced, fixed costs will be divided among more units and therefore ATC declines ● when ATC curve reaches its minimum, it begins to rise again b/c variable costs become more dominant than fixed costs ● the bottom of the U-shape occurs at the Q that minimizes ATC ○ efficient scale: the quantity that minimizes the ATC ○ AFC = TFC / TQ ○ AVC = TVC/ TQ marginal costs: how much does it cost to produce an additional unit of output? ○ MC = ΔTC/ ΔQ ○ the more we produce → the more the marginal costs rise ○ marginal cost curve → linear curve w/ a positive slope relationship btwn M  arg. Cost a nd ATC ○ whenever MC < ATC → ATC is falling ○ whenever MC > ATC, ATC is rising ○ i.e.: GPA: (parallel analogy) i f your next grade is above your GPA → GPA will rise but, if your next grade is below GPA → GPA will fall ○ graph: marginal cost curve crosses the average total cost curve at the efficient scale a perfectly competitive market has  the following characteristics: ○ many buyers and...