ECON101 Review Sheets
ECON101 Review Sheets ECON101195
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ECON101 Review Sheet #1 Lectures refer to material taught in class by Professor Link Chapters refer to the McConnellBrue textbook Topic 1 Nature and Method of Economics Limits, Alternatives and Choices (Chapter 1) Lecture 1 Limits, Alternatives, and Choices What is meant by the term economics? ● The social science concerned with how society, individuals, and institutions make optional (best) choices under conditions of scarcity. ● The branch of knowledge concerned with the production, consumption and transfer of wealth or simply the study of how we choose to use scarce resources in order to satisfy our wants What is a theory and how are theories tested? ● An abstract representation of the real world designed with the intent to better understand it. ● Economists employ the scientific method, in which they form and test hypotheses of causeandeffect relationships to generate theories, laws, and principles. Economists often combine theories into representation called models. What are the characteristics of capital as defined by economists? ● it’s “people made” ● takes current resources to produce ● enhances future production ● can be enhanced through investment (ex. factories, buildings, machines, highways) How can an economic theory be illustrated? ● graphs ● tables ● equations What is a positive statement? What is a normative statement? ● Positive economics objective and fact based ● Normative economics subjective and value based (opinion, cannot come to agreement) Why do economists disagree? ● disagree about the validity of the theory ● disagree about how to apply the theory What is meant by the terms microeconomics and macroeconomics? ● Microeconomics has to do with the small parts comprising the economy (ex. salaries of a company) ● Macroeconomics has to do with overall economy (aggregates) (ex. salaries of all U.S. citizens) What is meant by the phrase “economic perspective” or the economizing problem (marginal analysis?) ● economic perspective how economists believe that people think about everyday problems involving the choices in an environment with scarce resources. ● analyzing the changes in the situation that would result from a given action ● rational behavior players in the system use available information as they act to achieve their goals. people are adaptable and respond to changes in cost/benefit ● marginal analysis (economic perspective) undertake an activity if the marginal benefit exceed marginal cost. Involves examining a small increase or decrease in a particular economic activity. More Definitions: ● specialization enhances society’s output. Essential in achieving efficiency in the use of resources. ● free good a good is free when the amount available is greater than the amount people want at a zero price ● economic good a good is an economic good when the amount available is less than the amount people want at a zero price IMPORTANT GRAPH: ● Why is the MB downsloping? ○ the more you have of a good or service, the less extra satisfaction you receive from consuming an extra unit. ● Why is the MC upsloping? ○ as a business produces more of a good or service we expect the extra units of the good will cost more. Lecture 2 Limits, Alternatives, and Choices continued What are the two key facts underlying economics? ● scarcity the situation in which there are not enough resources to produce the goods and services necessary to meet all wants and needs of people in the economy. ○ individuals, firms and governments face constraints because of scarcity ● choice people make choices based on cost and benefit What does the term opportunity cost mean and why does the concept arise? ● Opportunity Cost cost of a good or service is measured in terms of the lost opportunity to pursue the best alternative activity with the same time and resources. ● The most highly valued opportunity or alternative forfeited when a choice is made. What is meant by the term efficiency? ● maximize the benefits for a given cost level ● achieve a given level of benefits at a minimum cost ● Exists when MB = MC What do economists mean when they use “marginal analysis”? ● marginal analysis undertake an activity if the marginal benefit exceed marginal cost. Involves examining a small increase or decrease in a particular economic activity. ● The rule for maximising profit or minimising losses is that the most profitable output or smallest loss is where marginal revenue (MR) = marginal costs (MC) What is a production possibility curve and how does it illustrate the concepts of scarcity, opportunity cost, efficiency, and economic growth? ● a graph showing the maximum possible combinations of goods that can be produced in an economy given the available factors of production and technology. ● assumptions underlying the construction of the PPC curve: ○ full employment and full production ○ only 2 products: X and Y ○ fixed technology ○ fixed resources Topic 2 Supply and Demand (Chapter 3) Lecture 3 Demand, Supply, and Market Equilibrium What is meant by the concept “law of demand”? ● law of demand as prices rise → quantity demand falls; as prices fall, quantity demand rises; inverse relationship What does an economist mean by the term relati prices? How does this relate to the law of demand? ● relative price cost of one good or service in relation to another good or service ● cost of inflation; inflation leads to a distortion in the allocation of resources, which eventually causes significant welfare losses over time What is the difference between change in the quantity demandedfor a good or service and a change in demanded for a good or service? ● Demand refers to the entire relationship between prices and the quantity of this product or service that people want at each of these prices. ○ should be thought of as "the demand curve." ● Quantity demanded refers to one particular point on the demand curve (not the entire curve). ○ refers to how much of the product is demanded at one particular price. ○ is the horizontal distance between the vertical axis and the demand curve. ● With an increase in demand: ○ the demand curve shifts to the right. ○ at every possible price, a greater quantity is demanded. ● With an increase in quantity demanded: ○ the price of the product decreases. ○ there has been a movement from one point on the demand curve to another point (further to the right) on the same demand curve. What is meant by the term “law of supply”? ● the quantity supplied of a good by sellers tend to increase as the price of the good increases and tends to decrease as the price decreases, other things being equal What does an economist mean by the term relative priceHow does this relate to the law of supply? ● relative price cost of inflation; inflation leads to a distortion in the allocation of resources, which eventually causes significant welfare losses over time What is the difference between change in the quantity supplifor a good or service and a change in supply for a good or service? ● Supply refers to the entire relationship between prices and the quantity of this product supplied at each of these prices. ○ should be thought of as "the supply curve." ● Quantity Supplied refers to one particular point on the supply curve (not the entire curve). ○ refers to how much of the product is supplied at one particular price. ○ is the horizontal distance between the vertical axis and the supply curve. ● With an increase in supply: ○ the supply curve shifts to the right. ○ at every possible price, a greater quantity is supplied. ● With an increase in quantity supplied: ○ the price of the product increases. ○ there has been a movement from one point on the supply curve to another point (further to the right) on the same demand curve. Why is the concept of equilibrium important to the discussion of supply and demand? ● The quantity where quantity demanded and quantity supplied are equal at a certain price. When a particular market is not in equilibrium, what adjustments do you expect to observe that will guide the market back to equilibrium? ● The price for the product will increase or decrease depending on the demand curve ● supply will increase or decrease so that will affect demand and both curves will shift towards the equilibrium How do equilibrium prices and quantities change in response to changes in demand and/or supply for a good or service? ● The demand relationship at a given price, what is the maximum amount that consumers would purchase (and continue to purchase)? ○ At a given quantity, what is the maximum price that would be paid for that quantity? (Thus, the curve measures the marginal benefit associated with consuming one more unit of the good in question). ● At a given price the supply curve shows the maximum amount of the product that will be supplied (and will continue to be supplied) by producers. ○ At a particular quantity, the supply curve shows the: ■ minimum price necessary to bring forth that output ■ marginal cost (MC) of producing that last unit What are “normal” goods and “inferior” goods? What are “substitute” goods and “complementary” goods? (with examples) How does each of these types of good affect our discussion of changes in the demand and supply of goods? ● an inferior good is a good that decreases in demand when consumer income rises (or rises in demand when consumer income decreases). ● Normal goods are those for which consumers' demand increases when their income increases. ● Two goods (C and D) are substitutes if using more of good C replaces the use of good D. For example, Pepsi Cola and Coca Cola are substitutes. ● Complementary goods and substitute goods are good examples to illustrate the difference between changes in demand v. changes in quantity demanded. Factors that cause a change in demand (shift the demand curve): ● PYNTE ○ Prices of related good substitute and compliments ○ Yinferior and normal goods income ○ Number of consumers ○ Tastes and preferences ○ Expectations Factors that cause a change in supply (shift the supply curve): ● TIPTEN ○ Taxes are the equivalent to an increase in input prices.This would cause a decrease in supply. Subsidies are the equivalent of a decrease in input prices and would cause an increase in supply. ○ Input prices and availability ○ Prices of substitutes in production ○ Taxes subsidies ○ Expectations ○ Number of suppliers and nature How to handle double shifts in supply and demand: ● Step 1: what market is showing in the supply and demand curves ● Step 2: what event OR events have occurred that might affect this market (PYNTE or TIPTEN) ● Step 3: know how the PYNTE and/or TIPTEN event shifts the appropriate curve. ● Step 4: single shifts can be evaluated using the configurations show on cmp31 ● Step 5: double shifts also can be evaluated using the configurations show on cmp31 ● Step 6: When double shifts occur, either the new P or new Q is ‘uncertain’ and depends on the absolute values of the shifts in the curves. More Definitions: ● demand relation showing the various maximum amounts of commodity that buyers would be willing and able to purchase at different prices, during a given period of time, holding all other factors the same (ceteris paribus). ● effective demand the quantity of a good that purchasers are willing and able to buy at a particular price, other factors the same. IMPORTANT EQUATIONS: demand equation: P = A mQ (A = y intercept, m = Δ P/ΔQ = slope of line) supply: P = C+dQ (C = y intercept, d = ΔP/Δ = slope of line) Lecture 7 Utility and Income and Substitution effects What is meant by the concepts of utility, marginal utility and the law of diminishing marginal utility? ● law of diminishing marginal utility law of economics stating that as a person increases consumption of a product, while keeping consumption of other products constant, there is a decline in the marginal utility that person derives from consuming each additional unit of that product. ● Utility refers to want satisfying power of a commodity. It is the satisfaction, actual or expected, derived from the consumption of a commodity. Utility differs from person toperson, placetoplace and timetotime. ● Marginal utility additional utility derived from the consumption of one more unit of the given commodity. It is the utility derived from the last unit of a commodity purchased. In regard to the law of demand what is meant by the concept of income and substitution effects? ● substitution effect when the price of a good falls/rises, the substitution effect is that part of the increase in quantity demanded of this good attributable to the universal tendency of consumers to substitute in favor of/away from goods whose relative price has fallen/risen. ○ an increase in the price of a good will encourage consumers to buy alternative goods. The substitution effect measures how much the higher price encourages consumers to use other goods, assuming the same level of income. ● income effect when the price of a good falls (increases), the income effect is that part of the change in quantity demanded attributable to the change in real income resulting from the price decline (increase). ○ looks at how the price change affects consumer income, and how much the rise in income will lead to lower demand What is the diamond water paradox and why did it arise? ● Water, which is more useful than diamonds, has a lower price than diamonds. This paradox was proposed by economists in the 1800s as a means to understand the role utility plays in the demand price of a good by differentiating between total utility and marginal utilit . ECON101 Review Sheet #2 Lectures refer to material taught in class by Professor Link Chapters refer to the McConnellBrue textbook Topic 3 The Market System and the Circular Flow (Chapter 2) Lecture 4 The Market System What does an economist mean by the term market? ● Any arrangement that people have for trading with one another What are the basic characteristics of an efficiently functioning market economy? ● Private property and freedom to negotiate binding legal contracts ○ property rights property legally acquired is protected from invasions by others ○ people are free to exchange, or give away property as long as their actions do not violate the rights of other people ○ encourages investment, property maintenance, and economic growth ○ property rights extend to intellectual property (ex. copyrights and patents) ● Freedom of enterprise and choice ○ individuals can be entrepreneurs ○ workers can choose jobs ○ consumers can buy what they want ○ owners can use resources as they want ○ there is limited government ● Democracy indicated the durability of freedom ○ security of property the foundation of material progress ○ economic players view security of property in the present by the fact that: ■ taxes are non confiscatory ■ contracts are enforced ■ trade is free ○ people need to know these freedoms will not disappear ● Self interest is the driving force ○ entrepreneurs aim to maximize total profits ○ property owners attempt to get the highest price for the rent or sale of their resources ○ laborers try to obtain the highest possible incomes ○ consumers seek to obtain their goods at the lowest price ● Markets and prices coordinate economic activity by providing information through prices and profits ○ rationing function of prices the process by which prices direct the existing supply of a product to users who value it most highly ○ allocative function of prices the process by which prices signal resources to enter into the production of goods whose price exceeds the cost of production and away from production of goods whose prices lie below production costs ● Competition among buyers and sellers is a controlling (regulating) mechanism ○ competition is based on the pursuit of profit ○ to have competition you need 2 or more independent sellers and freedom of sellers to enter and leave markets freely ○ markets determine prices and quantities because no one seller can dictate a price ○ if a firm does not follow principles of profit maximization, it will be forced out of business by those firms that do follow these principles ○ competition makes markets more able to adjust to changes in the economy ● There is a limited role of government (laissez faire) ○ enforce contracts, provide for public goods, provide key services to the public, account for market failure, and regulate markets where appropriate ● Specialization according to comparative advantage ○ comparative advantage a state or nation (or person) has a comparative advantage in some product when it can produce it at a lower opportunity cost than some other state or nation (or person) ● Stable medium of exchange ○ money whatever society accepts as a medium of exchange Who are the main “players” (economic decision makers) in a market economy? ● Households, Firms, Governments How can we use the circular flow diagram to illustrate the working of a market economy? Topic 4 Elasticities (Chapter 6) Lecture 5 Elasticity How is the term price elasticity of demand for a good “i” defined, and what is its significance to decision makers? ● elasticity is a: ○ measure of response ○ measure of strength of the response in percentage terms ○ an elasticity%Δresponse variable %Δt he variable that does the causing ● the ratio of the percentage change in the quantity of a good demanded to the percentage change in the price of the good. ● price elasticity of deman%ΔQdi %di How does one calculate the price elasticity of demand? ● Price elasticity of demand for goodΔquantity demanded x %ΔPrice x ● 5 steps in understanding the price elasticity of demand: ○ Step 1: you should be able to calculate the arc (midpoints) elasticity and arrive at a number (which will have a minus sign). The sign is minus because the law of demand says that the quantity demanded of good x is negatively related to the price. ○ Step 2: You should then, be able after coming up with a number for the elasticity (coefficient) to tell whether we are on an elastic, inelastic or unit elastic portion of the demand curve. ○ Step 3: After you have done step 2, you should be able to tell what will happen to total revenue if the price of the good rises or falls. ○ Step 4: You should be able to interpret the number for (coefficient of) price elasticity of demand. (For example, for a 1% change in the price you get a coefficient of the elasticity (the number)). Change in the quantity demanded in the opposite direction. ○ Step 5: You should be able to do little examples like we did in class when you have an initial quantity consumed, an initial price, and the price elasticity of demand. Then with a given percent change in price you should be able to predict the new quantity demanded. a) for any specified price range along a demand curve (arc elasticity)? ● b) for a particular price along a demand curve (point price elasticity)? ● Ed = %ΔQ %ΔP What are the important relationships between price changes, the price elasticity of demand for a good, and resulting changes in the total revenue (income) of businesses? ● Depending on how elastic a good is, a price change will either greatly change the demand for a product, or not affect demand at all. Elasticity is important when it comes to price change because if a company with an extremely elastic good raises their price their total revenue could decline because people would stop buying their good. What is meant by the concepts of price elasticity of supply, income elasticity of demand, and cross price elasticity of demand? Can you give illustrations so that you can see how they are applied? How can they be used? ● price elasticity of supply is the measure of the responsiveness of the quantity supplied of a particular good to a change in price (% Change in QS / % Change in Price). ● income elasticity of demand measures the responsiveness of the quantity demanded for a good or service to a change in the income of the people demanding the good, ceteris paribus. ● cross price elasticity of demand measures the responsiveness of the quantity demanded for a good to a change in the price of another good, ceteris paribus. change in quantity demanded of good A divided by change in price of good B. More Terms: ● Elastic demand the situation where quantity changes by a larger percentage than price along the demand curve, so that total revenue increases/decreases as price decreases/increases. The % change in the quantity demanded exceeds the % change in the price. ● Inelastic demand the situation where quantity changes by a smaller percentage than price along the demand curve, so that total revenue decreases/increases as price decreases/increases. The % change in the quantity demanded is less than the % change in the price. ● Unit elastic demand the situation where price and quantity change by the same percentage along the demand curve, so that total revenue remains unchanged as price changes. The % change in the quantity demanded is equal to the % change in the price. Topic 5 Government and Market Failures Lecture 6 Market Failures: Public Goods and Externalities What are the basic roles of the government? ● enforce laws/rules ● make economic decisions What is meant by the term market failure and why does such a failure justify government intervention into the market? ● market failure encompasses a situation where, in any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers ● Most economic arguments for government intervention are based on the idea that the marketplace cannot provide public goods or handle externalities. What is meant by the terms private goods, rivalry, excludability, public goods, and the free rider problem? Why do they justify intervention by the government into the market? ● private good A product that must be purchased in order to be consumed, and whose consumption by one individual prevents another individual from consuming it ● rivalry is a characteristic of a good. I.e. merchandise. A good can be placed along a continuum ranging from rivalrous (rival) to nonrival. The same characteristic is sometimes referred to as subtractable or nonsubtractable. ● excludability good or service is called excludable if it is possible to prevent people (consumers) who have not paid for it from having access to it. By comparison, a good or service is nonexcludable if nonpaying consumers cannot be prevented from accessing it. ● public good A product that one individual can consume without reducing its availability to another individual and from which no one is excluded. Economists refer to public goods as "nonrivalrous" and "nonexcludable". ● free rider problem he free rider problem refers to a situation where some individuals in a population either consume more than their fair share of a common resource, or pay less than their fair share of the cost of a common resource. What is meant by the term externality or spillover effect? Why do externalities justify intervention by the government into the market? ● spillover effects are economic events in one context that occur because of something else in a seemingly unrelated context. For example, externalities of economic activity are nonmonetary effects upon nonparticipants. Topic 6 Applications of SupplyDemand, Elasticities, and Policy (Chapter 3, 18, 24) Lecture 8 Tax Incidence What do we mean by tax incidence or tax burden? Why is it important? ● the analysis of the effect of a particular tax on the distribution of economic welfare. Tax incidence is said to "fall" upon the group that ultimately bears the burden of, or ultimately has to pay, the tax. What are the basic rules of tax incidence? ● The statutory burden of a tax does not describe who really bears the tax. ● The side of the market on which the tax is imposed is irrelevant to the distribution of tax burdens. ● Parties with inelastic supply or demand bear the burden of a tax. ● The more inelastic is the supply curve with a given demand curve, the more burden is on seller. ● The more inelastic is the demand curve with a given supply curve, the more burden is on buyers. Process for determining tax incidence associated with a sales tax: ● 1: start from initial equilibrium and impose a per unit tax on a seller of good x ● 2: shift the supply curve up (when you can) by the amount of the per unit tax a parallel shift since this is a per unit scale. ● 3: The new equilibrium price and quantity occur where the “new” supply curve intersects the demand curve. ● 4: Consumer’s burden: amount by which the price is higher (if it’s higher), multiplied by the new quantity. ● 5: Producer’s burden: about by which the perunit revenue is lower (if it’s lower), multiplied by the new quantity. ● 6: Total taxes = tax/unit of good multiplied by the new equilibrium quantity associated with the tax OR merely sum the consumer plus the seller’s burden. Lectures 9 & 10 Minimum Wage: What are the effects on employment predicted by supply and demand theory? What is a price floor? ● government or groupimposed price control or limit on how low a price can be charged for a product. A price floor must be higher than the equilibrium price in order to be effective. Lecture 11 Rent Controls What is a binding or effective price ceiling (or maximum price) ● A price ceiling is the maximum price a product can be charged according to the government. Do rent controls help the poor? Do they affect the quality of housing available for rent? How? ● Rent controls though made to help the poor often cause damage. When there are rent controls, say price ceilings, the price of rent may be put at a maximum that is too low for the landlord. The landlord will no longer be able to lease their property because rent no longer covers the landlord’s expenses. The quality of housing will decrease and entire apartment complexes have been known to close as well. What are the effects of a price ceiling set above equilibrium? ● If the price ceiling is set above the equilibrium price, it is known as a nonbinding price ceiling. It is possible for a surplus of the product to occur if the price being charged for the product is between the equilibrium price and the price ceiling What are the effects of a price ceiling set below equilibrium? ● If the price ceiling is set below the equilibrium price, this is known as a binding price ceiling. In this case, there will be a shortage of the product since even at the maximum price set, demand will exceed supply. Lecture 12 Scalping What is meant by the term “scalping”? ● A trading strategy that attempts to make many profits on small price changes. ● (ex.selling a ticket for a popular event at a price higher than the official one) Why do economists favor the idea of “scalping”? ● Many small profits can easily compound into large gains if a strict exit strategy is used to prevent large losses. Lecture 13 Economic impact on a tariff How do tariffs affect a market that was previously not regulated? ● Tariffs are used to restrict trade, as they increase the price of imported goods and services, making them more expensive to consumers. ● Tariffs provide additional revenue for governments and domestic producers at the expense of consumers and foreign producers. ● Governments may impose tariffs to raise revenue or to protect domestic industries from foreign competition, since consumers will generally purchase foreignproduced goods when they are cheaper. While consumers are not legally prohibited from purchasing foreignproduced goods, tariffs make those goods more expensive, which gives consumers an incentive to buy domestically produced goods that seem competitively priced or less expensive by comparison. How do quotas affect a market that was previously not regulated? ● A governmentimposed trade restriction that limits the number, or in certain cases the value, of goods and services that can be imported or exported during a particular time period. Quotas are used in international trade to help regulate tholume of trade between countries. They are sometimes imposed on specific goods and services to reduce imports, thereby increasing domestic production. In theory, this helps protect domestic production by restricting foreign competition. ● Both quotas and tariffs are protective measures imposed by governments to try to control trade between countries. ECON101 Review Sheet #3 Lectures refer to material taught in class by Professor Link Chapters refer to the McConnellBrue textbook Topic 7 Production and Costs (Chapter 9) Lecture 14 Cost of Production What do economists mean by the concept of cost? How do explicit costs differ from implicit costs? ● Economic costs payments that must be made to obtain and retain the services of a resource ● Explicit costs actual dollar payments by the firm for resources used in the production process that are owned by others. (ex. rent, electricity) ● Implicit costs opportunity costs of a firm of using resources owned by the firm itself rather than selling those resources. ○ reflect the income that could have been earned by SELLING or HIRING OUT the firm’s resources to others. What do economists mean by the term profit? Pure economic profit? Accounting profit? ● Pure economic profit The amount remaining after both explicit and implicit costs are subtracted from total revenue.(total revenue total cost) ● Accounting Profit amount remaining after explicit costs are subtracted from total sale revenue. total revenue total explicit costs) ○ the profit that appears on your accounting statement that you report to the government for tax purposes ○ overstates the success of your business because neglects implicit costs What is the relationship between pure economic profit and normal profit? ● Normal profit The typical amount of accounting profit that you would most likely earn in one of these ventures ● Ex. given your set of abilities you would have made a profit of $5,000 in your old venture. This $5,000 becomes an implicit cost that you then consider when figuring out your economic profit, because it is money you could have been making but instead gave up. After you add this implicit cost into your list of other explicit and implicit costs you can now subtract them all from your total revenue and find out your pure economic profit. What is meant by the short run and the long run in economic analysis? ● Short run A period too short to adjust the quantities of all the resources that it employs, but may have time to adjust one thing. ● Long run a long enough period to adjust the quantities of all resources that it employs. Old companies leaving or new companies entering the industry are also included in the long run. What is meant by the terms production function, marginal product, and average product? ● Production function the physical relationship between inputs and outputs. ○ This can be expressed as: Q = Q(X1, X2, X3, given technology) ■ X1, X2, X3 are inputs like labor, machines, etc. ■ Q = output ● Marginal product the extra output or added product associated with adding a unit of a variable resource. change in output associated with a one unit change in the input ○ MP = Δt otal product Δlabor input ● Average product output per unit of labor input ○ AP = total product= units of labor L What do economists mean by the term law of diminishing returns (or law of diminishing marginal productivity)? Give examples of its operation. ● Law of diminishing returns assumes that technology is fixed, so the techniques of production do not change. Units of a variable resource (ex. labor) are added to a fixed resource (ex. capital or land). At a certain point of adding marginal product, benefits will peak and then begin to decline if MP is still added. ● Ex. If more and more workers are hired to work with the same amount of equipment output will eventually cease to rise as more workers are hired but there is the same amount of work to be done as before. The same amount of product will be produced but the company will be losing money by paying more workers.) How is the shape of the marginal product curve related to the shape of the marginal cost curve? ● When units are cheap, costs will be low and productivity will be high. ● When workers put out less and less units, productivity will be less but cost will rise because workers still need to be paid. How does one draw an illustrative set of shortrun cost curves for a hypothetical typical firm? OR, what do the short run cost curves for the firm look like? THE AVERAGE/MARGINAL RULE ^^^ A s pertaining to the graph ^^^ ● If MC<AVC curve must be falling ● If MC>AVC curve must be rising ● If MC=AVC curve must be at minimum ● If MC<ATC curve must be falling ● If MC>ATC curve must be rising ● If MC=ATC curve must be at minimum Headline: “Unions cause sharp rises in wages in the U.S. auto industry. As a result they will be less competitive with Japan.” ● Both the U.S. and Japan are large producers of cars. If the U.S. industry increases wages they are making less as an industry when they sell each car because more of the money per unit is now going to their employees. The industry is then making less money and can no longer compete as much with Japan because they are weaker as an industry. Headline: “Productivity in the U.S. rises improving our competitiveness with other nations.” ● The U.S. increases productivity which means they can make more units in the same amount of time as before. This allows them to decrease the price of their product and the demand for it will then go up. This makes them more competitive because other nations with the same product will have to increase their productivity in order to be able to lower the price of their product while still making a profit. IMPORTANT EQUATIONS: fixed price = (AVC ATC)×quantity total accounting profit = total revenue total explicit costs total economic profit = total explicit costs total implicit costs MC = Δ L ΔQ MP = total produc ΔQ units of labor ΔL Topic 8 Pricing and Output Decisions in Pure Competition (Chapter 10) Lecture 15 Pure Competition: Price and Output Determination ● These graphs depicts a perfectly competitive industry and a firm within that industry Market Structure ● number of firms in the industry ● similarity of products (goods & services) ● knowledge of the market by key players ● ease of entry and exit in the industry What are the defining characteristics of the market structure known as perfect competition? ● large number of buyers and sellers of the product ○ no one seller can influence the price ● standardized product ○ consumer doesn’t care who they buy product from ● perfect knowledge on the part of buyers and sellers (ex. agriculture) ○ consumers know the price, buys from seller who charges the lowest price ○ producers also know prices and technology ● easy entry and exit from the market What is meant when it is said that a firm in a perfectly competitive market is a price taker? ● Price taker It cannot change the market price and can only adjust to it. This is because there are many firms that sell the same thing. If one firm were to raise its price, the demand for that firm’s product would fall because consumers would start buying from a different firm. Why does a perfectly competitive firm maximize shortrun profits (or minimize shortrun losses) by producing the quantity of output for which marginal cost is equal to marginal revenue? ● A firm does this so it can stay in the market and make the most possible profit by producing their product so that MR = MC. How can a supply curve for a perfectly competitive firm be derived from its cost curves? ● At a given price, points on the supply curve tell us the maximum amount of output that the firm would place on the market at that price. ○ You are given a price. ○ In the table that includes the MC schedule, create a column of whatever you have determined to be the given price. (ex. If price is $10, then the price column is a column of $10) Remember: MR=P=AR for perfectly competitive firm. ○ Use profit maximization rule to determine the maximum level of output the firm will produce. ■ MR=MC → prime output ■ MR>MC → expand output ■ MR<MC → contract output ○ Make sure the price is greater than the minimum average variable cost at the output you got. If so, the output you determined is a point on the firm’s supply curve. ○ Once you have found the profit maximizing level output, you have found a point on the firm’s supply curve since you have found “At a given price, the maximum amount of output that the firm would place on the market at that price.” How can a shortrun supply curve for an industry be derived from the shortrun supply curves of the individual firms in that industry? ● At each given price, horizontally sum the firm’s supply curves. We usually are able to assume that each firm is alike, so at each price just multiply the number of firms by the output that the typical firm will supply at that given price. What are the characteristics of longrun equilibrium in a perfectly competitive industry? How do the typical firm and the industry adjust in the long run to an increase or decrease in demand? ● The longrun average cost curve shows the lowest cost at which a firm is able to produce a given quantity of output in the long run. So, we would expect that in the long run, competition drives the market price to the minimum point on the typical firm’s longrun average cost curve. IMPORTANT EQUATIONS: Total profits are maximized at MC = MR MR = Δ TR ΔQ MC = Δ VC ΔTC ΔQ ΔQ TP = TR TC TR = P×Q ATC = P = AVC+AFC =TC Q TC = ATC×Q = TVC+TFC AVC = P =TVC Q TVC = AVC×Q AFC = ATC AVC TFC = AFC×Q IMPORTANT GRAPH: ● Make sure you can find the price, output, TR, ATC, TC, profit, AVC, TVC, AFC and TFC of this graph Topic 9 Pricing and Output Decisions in Pure Monopoly (Chapter 12) Lecture 15 Price and Output Determination: Monopoly ● These graphs depicts a perfectly competitive industry and a firm within that industry ● For monopolies, the firm’s graph acts as the market graph What is meant by the terms monopoly, natural monopoly, and franchise monopoly? ● monopoly: a market structure in which one firm accounts for 100% of industry sales monopoly ● natural monopoly: a monopoly protected from competition by technological barriers to entry or by ownership of unique natural resources ○ arises because single firm can supply good/service to entire market at smaller cost than two or more firms (ex. tap water) ● franchise monopoly: a monopoly protected from competition by a government grant of a monopoly privilege such as an exclusive license, permit, or patent. These can be in the form of patents, licenses and copyrights. (ex. British East India Company [accounted for half the world’s trade]) What is the relationship between average revenue and marginal revenue for a pure monopolist? ● Average revenue the revenue generated per unit of output sold. ○ total revenue quantity ● Marginal revenue The change in total revenue that results from selling one more unit of output What is the shortrun maximizing level of output and price and how do they differ from those of the perfectly competitive firm? ● monopolists are price makers, meaning they can affect the price of the product they sell because they are the only ones who sell it. ○ The only way for monopolists to sell more is to lower their price. However, then their MR<price, therefore they will lose more money than when they were selling at a higher price. ○ So monopolists are always going to try to remain at MC=MR What are the effects of changes in demand and costs on equilibrium price and quantity? ● Demand shifts can be caused by a wide variety of factors, but largely revolve around drivers of consumer behavior and circumstances. Why might a monopolist earn economic profits in the long run? ● A firm that has a monopoly doesn't face any price competition and can stay profitable. ● Barriers to entry (through technology or franchise monopolies) allow profits to be sustained over a long period of time. In what sense is a pure monopoly an imperfect market structure? ● Monopoly produces less output and charges a higher price than in the case of perfect competition. Monopoly and the concept of efficiency. ● A competitive firm will produce at P=MC, where the benefit to society is largest. ● A monopolist will produce where MR=MC, where there is loss in net benefit to society. ● ON GRAPH: Efficiency loss is the deadweight loss depicted in the triangle of a graph of losses between the vertical quantity line, and the supply and demand curves. IMPORTANT EQUATIONS: TR = P×Q AR = TR/Q = (P× Q)/Q = P MR = Δ TR ΔQ ECON101 Review Sheet #4 Lectures refer to material taught in class by Professor Link Chapters refer to the McConnellBrue textbook Topic 10 Public Goods and Externalities (Chapter 4, 5) Lecture 17 Market Failures: Public Goods and Externalities What are the basic roles of the government? ● providing a legal structure ● maintaining competition ● redistributing income (transfer payments, market intervention, taxation) ● reallocating resources ● promoting stability (unemployment and inflation mostly macroeconomics) What is meant by the term market failure and why does such a failure justify governmentintervention into the market? ● market failures occur when: ○ markets fail to allocate any resources whatsoever to the production of certain goods and services whose output is economically justified (ex. public goods). ○ markets bring about the wrong amounts of certain goods and services (ex. externalities). ○ markets provide inadequate information involving buyers/sellers. ● demand side market failures: occur in competitive markets when demand curves fail to reflect consumers’ full willingness to pay for a good or service. What is meant by the terms private goods, rivalry, excludability, public goods, and the free rider problem? Why do they justify intervention by the government into the market? ● private goods ○ rivalry when one person buys a good it is not available for consumption by another person. ○ excludability when a person is not willing to pay the market price, they cannot consume the good. This is the rationing function of prices (ex. the exclusion principle). Those who are willing to pay ‘get’ the goods. ● public goods aren’t subject to rivalry or excludability ○ public goods aren’t subject to the exclusion principle (that’s nonexcludability) ○ public goods are indivisible (that’s non rivalry) ○ public goods would not be provided by the private sector doe to the free rider problem. What is meant by the term externality or spillover effect? Why do externalities justify intervention by the government into the market? ● external (spillover) effects these involve costs or benefits associated with the production or consumption of a good or service and have some key characteristics ○ third party effects the action of one entity influencing another entity ○ noncompensation of/or by the third party ● negative externalities this is a situation where production or consumption costs are passed on to a third party without compensation being paid to the third party. ● externalities are those effects and costs not considered by a firm and the affect their product has on the consumer (ex. pollution, second hand smoke). The government intervenes so that the firm has to factor those externalities into the cost of production. Topic 11 Economics of Health Care Lecture 18 Health Economics: an Introduction to the Main Issues Why is the provision and financing of health care so important? What are dimensions of the problem? Why should you care? What are the objectives of any health care reform? ● Why you should care: ○ Approximately 18% of GDP is spent on health care in the U.S. ○ U.S. performs relatively poorly on health outcome statistics in world rankings ○ U.S. in 2011 insured a relatively small portion of its population ■ 16% of americans aren’t covered by health insurance ■ another 16 million are uninsured ○ Health care spending is high and rising fast ● implications of fundamental facts ○ most of us are healthy most of the time ○ risk pooling (getting insurance) is necessary because it is too expensive to self insure ○ problems of adverse selection arise with private health insurance markets ● Affordable care act want to get the whole population included. If you just have old people, the premiums would be higher because they need more care ● Adverse selection suggests that only sick people tend to get insured insurance companies want to guard against this ● Experience rating basing health insurance premiums on utilization experience of a specific insured group. Variations may occur by age, sex, risk factor. Private insurance. Under the new health care reform, insurance companies can’t deny people based on health history. ● Community rating basing health insurance premiums on the health care utilization experience of the entire population of a specific geographic area. Premiums are the same regardless age, sex, risk factor and previous health care. Why the large increase in health care expenditures (high costs)? ● aging population ● growth in income ● changes in tech ● growth in third party payments (insurance) ● obesity Why is it just as necessary to ration medical care as it is to ration all other goods and services? ● resources are scarce (not enough doctors, nurses, medical equipment etc) ● the opportunity cost is the value of the goods society must forego to have health care ● governments feel the pressure have to fund other things like roads, education etc. More funding of health means less funding for everything else. Health and education are the largest things in state budgets. What is the reasoning underlying the rationing of medical services under a market approach? ● How would a consumer decide whether or not to obtain health care under the market approach? ○ scarcity and choice entails costs and benefits ○ rational behavior people are adaptable and respond to changes in costs and benefits ○ marginal analysis undertake activity if marginal benefits exceeds marginal costs ● Rand Study did a major project where they varied the price that people have to pay for health services and watched people’s behavior in terms of the use of the system. ○ Findings: ■ Free ● almost 87% used the system ● admissions to hospital was 10.37 ■ 95% ● only 68% used the system ● admissions to hospital was 7.75 ■ Individual deductibles ● likelihood of using the system is much less ○ Conclusion likelihood of use, use of hospital and medical expenses all fall as the price goes up. Downward sloping demand curve for health care. This is because not all care is life and death so there is choice. ● Moral Hazard tendency of one party to make an agreement to alter their behavior in a way that is costly to the other party. ● Pure market system ○ patients are viewed as using marginal analysis ○ price rations who sees physicians ○ efficient doctors see sickest patient ○ probably meets criteria of liberty ○ not equitable without government subsidies What is managed care? ● Managed care → HMOs ○ employ their own physicians and contract for specialized services with outside providers and hospitals. ○ then they contract with business firms and government units to provide medical care to their workers. ○ general practitioner is a “gate keeper” ○ consumers pay a set annual fee doctors have an incentive to ‘not over treat’. ○ utilization review panels monitor performance patterns of docs in the HMO ● Managed care → Characteristics of PPOs and POS arrangements ○ much if not all patient care provided through a network ○ centralize oversight on use of resources ● Preferred Provider Organizations (PPOs) ○ no gatekeeper ○ lower coinsurance rates and deductibles for using resources in the networ
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