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Exam 2 Study Guide

by: Kaitlyn West

Exam 2 Study Guide ECON-E 201 Peter Olsen

Kaitlyn West
GPA 4.0
Introduction to Microeconomics
Peter Olsen

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About this Document

Includes the important details from Utility Theory and Chapters 5-8.
Introduction to Microeconomics
Peter Olsen
Study Guide
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This 6 page Study Guide was uploaded by Kaitlyn West on Wednesday March 4, 2015. The Study Guide belongs to ECON-E 201 Peter Olsen at Indiana University taught by Peter Olsen in Winter2015. Since its upload, it has received 350 views.


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Date Created: 03/04/15
Microeconomics Exam 2 Study Guide Utility Theory Vocabulary Utility satisfaction Total Utility the cumulative satisfaction received from aIunits of a good that are consumed Marginal Utility MU the satisfaction received from the last good consumed Law of Diminishing Marginal UtilityBeyond some point the more units of a good you consume the less marginal utility each additional unit provides Kev Concepts Total Utility increases as consumption increases but marginal utility decreases as consumption increases Total utility is maximized when the marginal utility per dollar of each good is equal and all income is spent Consumer Equilibrium The rst good that a consumer will purchase is the good that has the highest Marginal UtilityPrice MUP Diminishing marginal utility is the reason that consumers are only willing to buy more of a good if the price drops Thus demand curves slope downward The scarcer a good is the higher its marginal utility and its price Price depends on marginal utility not total utility Applications At the aggregate level the Utility Model predicts consumption patterns of the general population Irrational decisions are outweighed by rational decision makers Marginal Utility Theory can explain irrational voting behavior Income Effect change in quantity demanded by changing the relative prices of a goods positive for normal goods negative for inferior goods Substitution Effect the increased quantity demanded resulting from a lower relative price If income effect outweighs substitution effect the demand curve slopes upward Chapter 5 Demand Vocabulary Elasticity a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants Price Elasticity of Demand a measure of how much the quantity demanded of a good responds to a change in the price of that good computed as a percentage change in quantity demanded divided by the percentage change in price Total Revenue the amount paid by buyers and received by sellers of a good computed as the price of the good time the quantity sold Key Concepts Demand for a good is elastic if the quantity demanded responds substantially to a change in price Demand for a good is inelastic if the quantity demanded responds only slightly to a change in price Goods with close substitutes tend to have more elastic demand because its easier for consumers to switch from that good to a substitute Necessities tend to have inelastic demands Luxuries tend to have elastic demands Narrowly de ned markets tend to have more elastic demand than broadly de ned markets because its easier to nd close substitutes for narrowly de ned goods tanktops vs clothes Goods tend to have more elastic demand over longer time hodzons Elastic PE gt 1 atter demand curves Inelastic PE lt 1 steeper demand curves Perfectly Elastic PE in nity horizontal demand curve Perfectly Inelastic PE 0 vertical demand curve Unit Elasticity PE 1 Inelastic Demand price and revenue move in the same direction Elastic Demand price and revenue move in opposite directions Unit Elastic Total Revenue remains constant when price changes ELASTICITY IS NOT CONSTANT ALONG A LINEAR DEMAND CURVE Calculations Price Elasticity of Demand Change in Quantity Demanded Change in Price 0 All price elasticities are reported as positive numbers 0 Change in Quantity Demanded QZQlQlQZ2 Change in Price P2P1P1P22 Use the Midpoint Method As shown above Applications 0 Income Elasticity of Demand a measure of how much the quantity demanded of a good responds to a change in consumers income computed as a percentage change in quantity demanded divided by the percentage change in income 0 normal goods positive inferior goods negative CrossPrice Elasticity of Demand a measure of how much the quantity demanded of one good responds to a change in the price of another good computed as the change in quantity demanded on the rst good divided by the change in price of the second good 0 positive for substitutes negatives for complements Chapter 5 Supply Vocabulary 0 Price Elasticity of Supply a measure of how much the quantity supplied of a good responds to a change in the price of that good computed as the change in quantity supplied dividing by the change in price Key Concepts 0 Supply is elastic if quantity supplied responds substantially to a change in price 0 Supply is inelastic is quantity supplied responds only slightly to changes in price 0 Key determinant is the time period being considered 0 Supply is more elastic in the long run 0 Elastic PE gt 1 atter supply curve Inelastic PE lt 1 steeper supply curve 0 Perfectly Elastic PE 0 horizontal supply curve 0 Perfectly Inelastic PE in nity vertical supply curve Calcul anns Price Elasticity of Supply Change in Quantity Supplied Change in Pric 0 e Remember to use the Midpoint Method See PE of Demand Chapter 6 Vocabulary Price Ceiling a legal maximum on the price at which a good can be sold Price Floor a legal minimum on the price at which a good can be sold Tax Incidence the manner in which the burden of a tax is shared among participants in a market Key Concepts Applic Price ceilings are binding when they are set below the market equilibrium price o Results in a shortage so a mechanism for rationing goods will develop o Not all buyers bene t Price oors are binding when they are set above the market equilibrium price o Results in a surplus so undesirable rationing mechanisms develop o Sellers begin to compete by quality Price controls obscure the signals that normally guide the allocation of society s resources Price controls often hurt those who are trying to help Taxes discourage market activity 0 Quantity decreases demand decreases Buyers and sellers share the burden of taxes but not equally o No matter which group the tax is imposed on the outcome will be the same Tax burden falls more heavily on the side of the market that is less elastic anns Economic Effects of a tax 0 Market price changes 0 Behavior changes less production less consumption 0 Tax drives wedge between price paid and price received Only people pay taxes business can NOT pay taxes Chapter 7 Vocabulary Welfare Economics the study of how the allocation of resources affects economic wellbeing Consumer surplus the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it Marginal Buyer the buyer who would leave the market rst if the price were any higher Producer Surplus the amount a seller is paid minus the cost of production If an allocation of resources maximizes total surplus we say that the allocation exhibits ef ciency Equality whether the various buyers and sellers in the market have a similar level of economic wellbeing Kev Concepts Applic Individuals have different consumer surpluses Total consumer surplus sum of individual consumer surpluses A lower price makes buyers of a good better off In most markets consumer surplus represents economic well being Producers are willing to take a job or sell a product if the price they would receive exceeds the cost of the jobproduct Individual producer surpluses can differ Total producer surplus sum of individual producer surpluses At any quantity the price given by the supply curve shows the costs of the marginal seller the seller who would leave the market rst if the price were any lower anns Consumer surplus the area above the price and below the demand curve The area below the price and above the supply curve measures the producer surplus in a market Free markets allocate the supply of goods to the buyers who value them most highly as measured by their willingness to pay Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost 0 Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus Chapter 8 Vocabulary o Deadweight Loss the fall of in total surplus that is the result of a policy that distorts a market outcome 0 Marginal Tax Rate the tax on the last dollar of earnings 0 Underground Economy engaging in illegal economic activity to evade taxes Key Concepts 0 The impact of a tax is the same whether the tax is levied on buyers or sellers of a good 0 Price paid by the buyers rises 0 Amount received by sellers falls 0 Government tax revenue T x Q 0 Government Tax Revenue the rectangle between the supply and demand curve 0 Consumer and Producer surplus are both reduced when a tax is enacted Thus the losses to buyers and sellers from a tax exceed the revenue raised by the government 0 Taxes cause markets to allocate resources inef ciently Gains from trade are less than the cost of the tax so the trades are not made once the tax is imposed The size of the deadweight loss is determined by the price elasticities of supply and demand 0 The greater the elasticities of both supply and demand are the larger the deadweight loss is Applications 0 Change in Welfare Change in consumer surplus negative change in produced surplus negative change in tax revenue positive


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