Microeconomics Test 1 Study Guide
Microeconomics Test 1 Study Guide ECON 2106
Popular in Principles of Microeconomics
verified elite notetaker
Popular in Economics
This 26 page Study Guide was uploaded by Chapman Lindgren on Monday September 19, 2016. The Study Guide belongs to ECON 2106 at University of Georgia taught by Till Schreiber in Fall 2016. Since its upload, it has received 162 views. For similar materials see Principles of Microeconomics in Economics at University of Georgia.
Reviews for Microeconomics Test 1 Study Guide
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 09/19/16
Microeconomics Midterm 1 Study Guide Microeconomics (ECON 2106) Chapter 1 Notes Economics is driven by principles of scarcity and incentives. Scarcity is our inability to satisfy all our wants. Because we face scarcity, we must make choices. An incentive is a reward that encourages an action or a penalty that discourages an action. Microeconomics is study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments. It is, more simply put, the study of economics at an individual, group or company level. Example of micro: why are students buying more e-books and fewer hard copy books? Here are four additional examples of microeconomics. Macroeconomics is the study of the performance of the national and global economies. Example of macro: why is the unemployment rate in the US so high? Goods and Services are the objects that people value and produce to satisfy human wants. A good would be something like a candy bar or a t-shirt. A service might be a haircut, taxi ride or mail delivery. Efficiency and Social Interest A resource is efficient if it is not possible to make a person better off without making someone else worse off. For example, Apple sells iPhones to people all around the world but the conditions their laborers face in factories are far less than ideal. Equity is fairness, however “fairness” is subjective, especially among economists. Economic Ways of Thinking 1. A choice is a tradeoff a. On a Saturday night, will you stay home and study or go out and have fun? You must make a choice and every choice is a tradeoff. 2. People make rational choices by comparing benefits and costs a. Ideally, you’d make a rational choice. A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice. 3. Benefit is what you gain from something Microeconomics Midterm 1 Study Guide a. The benefit of something is the gain or pleasure that it brings and is determined by preferences- by what a person likes and dislikes and the intensity of those feelings. b. Economists measure this as the most you are willing to give up for something. 4. Cost is what you must give up to get something a. The opportunity cost of something is the highest valued alternative that must be given up to get it. Say Chipotle is giving out free burritos. Every student on campus goes to claim their free snack. In order to actually get the free burrito, you must spend one hour of your time waiting in line. Alternatively, you could go pay $7.00 for a burrito somewhere else and use your remaining time to be productive. 5. Most choices are “how-much” choices made at the margin a. You want to study and play video games, but you must decide how many minutes to allocate to each activity in an allotted period of time. You compare the benefit of a little more study time with its cost- you make your choice at the margin. 6. Choices respond to incentives a. A change in marginal cost or a change in marginal benefit changes the incentives that we face and leads us to change our choice. The central idea of economics is that we can predict how choices will change by looking at changes in incentives. Incentives are also the key to reconciling self-interest and the social interest. Economist as a Social Science Positive Statements: a statement about what is. It may be wrong, but economists can test it. For example: Higher interest rates will reduce house prices. This may be right or wrong, but economists can test it by checking it against facts and data. Normative Statements: a statement about what ought to be. You may agree or disagree with it, but you can’t check it. For Example: The U.S. unemployment rate should be lower. Unscrambling Cause and Effect: Economists like to use positive statements about cause and effect. They can check them using an economic model. Economic Model: a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand. Economics as a Policy Advisor Economics is a toolkit for advising governments and businesses and for making personal decisions It can’t help with the normative part, that’s the policy goal, but it can help to clarify what the goals are. Microeconomics Midterm 1 Study Guide To add: Incentive, more about economic models, land labor capital entrepreneurship, PPF (Production Possibilities Frontier): the boundary btwn the combinations of goods and services that can be produced and those than cant o points outside the PPF and unattainable - the PPF shows what is technologically feasible to produce o points within the PPF line are attainable but inefficient o we achieve Production Efficiency if we cannot produce more of one good without producing less of something else o outward bowing PPF means that as the quantity produced of each good increases so does its opportunity cost o all points on the PPF line are efficient Opportunity Cost is a ratio Preferences: the likes and dislikes of consumers Marginal Benefit: the benefit derived from a consumer by consuming one more unit of something o this is measured by how much a consumer is willing to pay for an additional unit of something o measure derived from the consumer side The Principle of decreasing marginal benefit: general principle that the more we have of something the smaller its marginal benefit and the less we are willing to pay for an additional unit of it Allocative Efficiency: when we cannot produce more of one good without giving up some other good that we value more highly o marginal benefit = marginal cost —> efficient quality being produced All points on the PPF achieve production efficiency but only the one point where Marginal benefit and Marginal cost intersect achieves both production and allocative efficiency Economic growth Microeconomics Midterm 1 Study Guide o technological change: the development of new goods and a better way to produces goods and services o capital accumulation: o cost of economic growth: PPF and Opportunity Costs Production Possibilities and Opportunity Cost The quantities of goods and services that we can produce are limited by our available resources and by technology o Tradeoff: increased production of 1 good = decreased production of something else Production Possibilities Frontier (PPF): the boundary between those combinations of goods and services that can be produced and those that cannot The PPF illustrates scarcity because the points outside the frontier are unattainable. However, any point inside the PPF is considered attainable Microeconomics Midterm 1 Study Guide Production Efficiency We achieve production efficiency if we produce goods and services at the lowest possible cost Production efficiency occurs are all points on the PPF o Points inside the PPF production are considered inefficient, meaning we are giving up more than necessary of a good to produce “x” number of another good Production inside PPF is inefficient because resources are either unused, misallocated or both o Resources are unused when they are idle but could be working o Resources are misallocated when they are assigned to tasks for which they are not the best match (having a chef cut grass all day) Tradeoff along PPF and Opportunity Cost Tradeoffs involve an opportunity cost. The opportunity cost of an action is the highest-valued alternative forgone There are only 2 goods along the PPF so there is only 1 alternative foregone o Ex: To produce more pizzas we must produce less cola. The opportunity cost of producing additional pizza is the cola we must forgo decrease∈quantityof good produced Opportunity cost is a ratio: increase∈quantityof other good produced The slope of PPF measure opportunity cost Using Resources Efficiently We achieve production efficiency at every point on the PPF, but which is best? o Allocative efficiency: when goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit The PPF and Marginal Cost The marginal cost of a good is the opportunity cost of producing one more unit of it o Simply put, marginal cost is the cost of moving from one point on the frontier to another On the graph to the right, moving from point “Q” to point “R”, we can see that the marginal cost of going from 5 computers to 6 is 1 Microeconomics Midterm 1 Study Guide The expansion of production possibilities is called economic growth. Economic growth increases our standard of living The Cost of Economic Growth What causes economic growth? Technological change and capital accumulation o Technological Change: development of new goods and of better ways of producing goods and services o Capital Accumulation: growth of capital resources, including human capital If we use our resources to develop new technologies and produce capital, we must decrease our production and consumption of goods and services o New technologies and new capital have an opportunity cost Gains from Trade Producing only one or a few goods is called specialization. People gain by specializing the production of the good in which they have a comparative advantage and trading with others Microeconomics Midterm 1 Study Guide Comparative Advantage and Absolute Advantage A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost that anyone else. A person has an absolute advantage if that person is more productive than others Absolute advantage involves comparing productivities while comparative advantage involves comparing opportunity costs. You can always have a comparative advantage even if you have no absolute advantage Achieving the Gains from Trade ( Liz and Joe example from textbook) Liz and Joe produce the good in which they have a comparative advantage: o Liza produces 30 smoothies and 0 salads o Joe produces 30 salads and 0 smoothies Liz and Joe Trade: o Liza sells Joe 10 smoothies and buys 20 salads o Joe sells Liz 20 salads and buys 10 smoothies After trade: o Liz has 20 smoothies and 20 salads o Joe has 10 smoothies and 10 salads Both trade lines (red) have an equal slope because their exchange was of an equal ratio Economic Coordination To reap gains from trade, the choices of individuals must be coordinated Microeconomics Midterm 1 Study Guide To make coordination work, four complimentary social institutions have evolved over the centuries: o Firms: an economic unit that hires factors of production and organizes them to produce and sell goods and services. Ex: Wal-Mart buys or rents large buildings, equips them with storage shelves and checkout lanes, and hires labor o Markets: any arrangement that enables buyers and sellers to get information and to do business with each other. A place where people buy and sell goods such as fish, meat, fruits, and vegetables o Property rights: the social arrangements that govern the ownership, use and disposal of anything people value. Real property includes land and buildings Financial property includes stocks and bonds and money in the bank Intellectual property is the intangible product of creative effort o Money: any commodity or token that is generally acceptable as a means of payment. In the book’s example of Liz and Joe, they didn’t need money because they exchanged salads and smoothies. Circular Flows Through Markets The figure below illustrates how households and firms interact in the market economy Factors of production and goods and services flow in one direction (red). Money flows in the opposite direction (green). Microeconomics Midterm 1 Study Guide Example Problem 1 : My neighbor and I have the same value of Saturday afternoon leisure. But, our cars need oil changes and lawns need mowing. Time to change oil Time to mow lawn Jim 15 minutes 30 minutes Till 60 minutes 45 minutes a) Who has an absolute advantage in chores? Jim, he’s better and more productive at doing both chores. b) In a no trade scenario, Jim works for 45 minutes, Till works for 105 minutes. c) What are the opportunity costs? a. Jim: 2 oil changes. The opportunity cost of Jim mowing 1 lawn is 2 oil changes b. Till: ¾ of an oil change. i. Till has comparative advantage in mowing the lawn because he has a smaller opportunity cost. Jim has to give up more to mow the lawn. Till has comparative advantage in mowing lawns Jim has comparative advantage in changing oil d) Specialization and Gains from Trade a. Till mows both lawns; Jim changes oil for both cars b. Till works for 90 minutes; Jim works for 30 minutes i. Both are now better off than how they were in part b Example Problem 2 : Suppose Virginia and Nebraska both produce Tobacco and Corn. Assume that Virginia and Nebraska have the same amount of productive inputs. Microeconomics Midterm 1 Study Guide a) What is the opportunity cost of producing one bushel of corn in both states? (Opportunity cost can be found by calculating the slope of the PPF. Linear PPF = constant opportunity cost). 600 6 3 a. Virginia: 400= 4 2 tons of tobacco (for every 1 bushel of corn) b. Nebraska: 4 tons of tobacco (for every 1 bushel of corn) 5 b) Nebraska has the comparative advantage in producing corn because it has lower opportunity cost. Virginia has the comparative advantage in producing tobacco c) Suppose they trade. What is the price range of corn you might expect to see (in terms of tobacco)? a. Trade line moves from (0,600) to (1000,0). The slope of this line would be in between 3/2 and 4/5. The actual location of the point depends on how good the negotiators from each state are. Example Problem 3 : According to the theory of comparative advantage, country x would find it most advantageous to...? Wheat Corn X 10 5 Y 8 8 Microeconomics Midterm 1 Study Guide a) Export both wheat and corn b) Import both wheat and corn c) Not trade d) Export wheat and import corn e) Export corn and import wheat Coordinating Decisions Markets coordinate decisions through price adjustments o Suppose a ton of people who want to buy ice cream can’t. To make buying and selling plans the same, more ice cream must be offered or fewer people can want ice cream. Increasing the price of ice cream will force this equilibrium When the price is right, buying plans and selling plans match Markets and Prices Competitive market: market that has many buyers and sellers so no one individual can influence prices Money price: the money required to buy something Relative price: the ratio of its money price to the money price of its next best alternative – its opportunity cost Demand If you demand something, you: o Want it o Can afford it o Have made a definite plan to buy it The law of demand states that: o Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded o The lower the price of a good, the larger is the quantity demanded Why does price change affect the quantity demanded? o Substitution effect: when the opportunity cost/relative price of a product rises, people look for substitutes – decreases demand for the original product o Income effect: when prices rise relative to income, people cannot afford what they previously bought so demand increases Demand Curve and Demand Schedule o Demand refers to the entire relationship between the price of a good and the quantity demanded of the good o Demand Curve shows the relationship between quantity demanded of a good and its price when all other influences on consumers remain the same Microeconomics Midterm 1 Study Guide o Reducing / increasing quantity of good demanded refers to moving along the demand curve – increasing / decreasing demand refers to shifting the entire demand curve 6 Main Factors that Change Demand 1. the prices of related goods A substitute is a good that can be used in the place of another A compliment is a good that is used in conjunction with another good 2. expected future prices if the price of a good is expected to rise in the future, current demand increases and the demand curve shifts to the right 3. income when income increases, consumers buy more of most goods and the demand curve shifts to the right a normal good is a good for which demand increases when income increases an inferior good is a good for which demand decreases when income increases (ex: people eat less at McDonalds and more at Chipotle because they can now afford it 4. expected future income and credit 5. population 6. preferences Supply if a firm supplies a good or service, then the firm: o has the resources and tech to produce it o can profit from producing it o has made a definite plan to produce and sell it Resources and technology determine what is possible to produce The Law of Supply states that: o Other things remaining the same, the higher the price of a good, the greater is the quantity supplied o The lower the price of a good, the smaller is the quantity supplied o The law of supply results from the general tendency for the marginal cost of producing a good or service to increase as the quantity produced increases 6 Main Factors that Change Supply: 1. the prices of factors of production 2. the prices of related goods produced 3. expected future price 4. the number of suppliers 5. technology 6. state of nature Microeconomics Midterm 1 Study Guide Market Equilibrium equilibrium price: the price at which the quantity demanded = the quantity supplied equilibrium quantity: the quantity bought and sold at the equilibrium price Price Elasticity of Demand As supply decreases, the equilibrium price rises and the equilibrium quantity decreases o But does the price rise by a larger amount and the quantity decrease by a little? The responsiveness of the quantity demanded of a good to a change in its price in terms of the slope of the demand curve Price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same o Calculating elasticity of demand: change∈quantitydemanded change∈price Example: the price of a pizza is $20.50 and the quantity demanded is 9 pizzas per hour. The price of a pizza falls to $19.50 and the quantity demanded is 11 pizzas per hour $20 average between 2 points, 10 pizzas average between 2 points (change in pizzas = 2 so 2/10 * 100 = 20%) = 20% change in pizzas demanded / 5% change in price = 4 o Price goes up, quantity demanded goes down Average Price and Quantity By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls o Elasticity means it will change easily. If elastic price changes, elastic demand changes drastically A Units-Free Measure: elasticity is a ratio of percentages, so a change in the units of measurement of price or quantity leaves the elasticity value the same Minus Sign Elasticity: the formula yields a negative value, because price and quantity move in opposite directions. But it is the magnitude, or absolute value, that reveals how responsive the quantity change has been to a price change. Microeconomics Midterm 1 Study Guide Inelastic and Elastic Demand Demand can be inelastic, unit elastic, or elastic, and can range from zero to infinity. If the quantity demanded doesn’t change when the price changes, the price elasticity of demand is zero and the good has a perfectly inelastic demand. o A perfectly inelastic demand curve is vertical Unit Elastic Demand: if the percentages change in the quantity demanded equals the percentage change in price. The price elasticity of demand equals 1 and the good has unit elastic demand Microeconomics Midterm 1 Study Guide If the percentage change in the quantity demanded is smaller than the percentage change in price, The price elasticity of demand is less than 1 and the good has inelastic demand If the percentage change in the quantity demanded is greater than the percentage change in price, The price elasticity of demand is greater than 1 and the good has elastic demand If the percentage change in the quantity demanded is infinitely large when the price barely changes The price elasticity of the demand is infinite and the good has a perfectly elastic demand Factors that influence the Elasticity of Demand: The closeness of substitutes o The closer the substitutes for a good or service, the more elastic is the demand for the good or service o Necessities, such as food or housing, generally have inelastic demand o Luxuries, such as exotic vacations, generally have elastic demand The proportion of income spent on the good o The greater the proportion of income consumers spend on a good, the larger is the elasticity of demand for that good The time elapsed since a price change o The more time consumers have to adjust to a price change, or the longer that a good can be stored without losing its value, the more elastic is the demand for that good Total Revenue and Elasticity The total revenue from the sale of a good or service equals the price of the good multiplied by the quantity sold. Revenue is the total sold (price x quantity) When the price changes, total revenue also changes But a rise in price doesn’t always increase total revenue Microeconomics Midterm 1 Study Guide The change in total revenue due to a change in price depends on the elasticity of demand: If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent, and total revenue increase If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent, and total revenues decrease If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and total revenue remains unchanged The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change (when all other influences on the quantity sold remain the same). If a price cut increases total revenue, demand is elastic. If a price cut decreases total revenue, demand is inelastic. If a price cut leaves total revenue unchanged, demand is unit elastic. Your Expenditure and Your Elasticity if your demand is elastic, a 1% price cut increase the quantity you buy by more than 1% and your expenditure on the item increases. If your demand is inelastic, a 1% price cut increases the quantity you buy by less than 1 percent and your expenditure on the item decreases. If your demand is unit elastic, a 1% price cut increases the quantity you buy by 1% and your expenditure on the item does not change. Income Elasticity of Demand The income elasticity of demand measures how the quantity demanded of a good respond to a change in income, other things remaining the same. percentagechange∈quantitydemanded percentagechange∈income If the income elasticity of demand is greater than 1 (positive), demand is income elastic and the good is a normal good. If the income elasticity of demand is greater than zero but less than 1, demand is income inelastic and the good is a normal good. Microeconomics Midterm 1 Study Guide If the income elasticity of demand is less than zero (negative) the good is an inferior good. Cross Elasticity of Demand The cross elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of a substitute or a complement, other things remaining the same. The formula for calculating the cross elasticity is: percentagechange∈quantitydemanded percentagechange∈priceof substitute∨compliment The cross elasticity of demand for o A substitute is positive o A compliment is negative Price elasticity of demand = % change quantity demanded / % change in price Microeconomics Midterm 1 Study Guide ∆Q 1 Quantity: = =22.2 Qave 4.5 ∆P 4 Price: = =66.7 Pave 3.5 Revenue at Point A = Q a PA = $3.5 = $15 Revenue at Point B = Q b PB = $6.4 = $24 Elastic demand: when price changes by 1% and demand changes by more than 1% Elastic price: when the price goes up, customers buy much less Elasticity of Supply When the demand for a good increases, its equilibrium price rises and the equilibrium quantity of the good increases o Does price rise by a large amount and the quantity increases for a little? o Does the price barely rise and the quantity increases by a large amount? This depends on the responsiveness of the quantity supplied of a good to a change in its price Depends on the elasticity of supply of the good Elasticity of Supply measures the responsiveness of the quantity supplied to a change in the price of a good, when all other influences on selling plans remain the same. change∈quantitysupplied Calculating the Elasticity of Supply: change∈price Microeconomics Midterm 1 Study Guide Factors that Influence the Elasticity of Supply: Resource substitution possibilities o The easier it is to substitute among the resources used to produce a good or service, the greater is its elasticity of the supply Time frame for supply decision o The more time that passes after a price change, the greater is the elasticity of supply o Momentary supply is perfectly inelastic. The quantity supplied immediately following a price change is constant o Short run supply is somewhat elastic o Long run supply is the most elastic Resource Allocation Methods Market price: like college in the US Command: like college assignment system in Germany. Resources are allocated by the order of someone in authority Majority rule: Content: getting picked for a job over someone else First come, first serve: wait in line the longest Lottery: random Personal characteristics: restrictions of allocation on what people of certain gender/race could do/buy/etc. Force: if you want something you have to take it Benefit, Cost, and Surplus Demand, Willingness to Pay, and Value Value: what we get Microeconomics Midterm 1 Study Guide o The value of one or more unit of a good or service is its marginal benefit A demand curve is a marginal benefit curve o We measure value as the maximum price that a person is willing to pay Willingness to pay determines demand Price: what we pay Individual Demand and Market Demand Individual demand is the relationship between the price of a good and the quantity demanded by one person Market demand is the relationship between the price of a good and the quantity demanded by all buyers The market demand curve is the horizontal sum of the individual demand curves Lisa’s marginal benefit is $1 for the 30 slice Microeconomics Midterm 1 Study Guide th Nick’s marginal benefit is $1 for the 10 slice For society overall, The white rectangle under the pink line is the amount she pays. She still gets that value out of the pizza. Consumer surplus: (the triangle area under Lisa’s and Nick’s individual demand curve and above the pink line). This represents the extra money the consumer would’ve been willing to pay to receive the amount of pizza that they each purchased Supply and Marginal Cost To make a profit you need to sell at a price higher than your production costs Firms are in business to make a profit Firms distinguish between cost and price Supply, Cost, and Minimum Cost is what the producer gives up, price is what they receive Marginal cost: the cost of one more unit of a good or service o Marginal cost is the minimum price that a firm is willing to accept, but minimum supply-price determines supply A supply curve is a marginal cost curve Individual Supply and Market Supply Microeconomics Midterm 1 Study Guide The relationship between the price of a good and the quantity supplied by one producer is called individual supply. The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply. Producer Surplus Producer Surplus is the excess amount received from the sale of a good over the cost of producing it To calculate the producer surplus, pricereceived forthegood−supply pricemarginal cost) Is the Competitive Market Efficient? Efficiency of Competitive Equilibrium In equilibrium, the quantity demanded = the quantity supplied When production is: o Less than the equilibrium quantity, MSB > MSC o Greater than the equilibrium quantity, MSC > MSB o Equal to the equilibrium quantity, MSC = MSB Microeconomics Midterm 1 Study Guide Resources are used efficiently when marginal social benefit social benefit equals marginal social cost When efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized The Invisible Hand Adam Smith’s invisible hand idea in the Wealth of Nations implied that competitive markets send resources to their highest valued use in society Consumers and producers pursue their own self-interest and interact in markets Market transaction generate an efficient- highest value – use of resources Market Failure Markets don’t always achieve an efficient outcome Market failure arises when a market delivers an inefficient outcome Market failure can occur because o Too little of an item is produced (underproduction) OR o Too much of an item is produced (overproduction) Underproduction The efficient quantity is 10,000 pizzas per day. If production is restricted to 5,000 pizzas a day, there is underproduction and the quantity is inefficient A deadweight loss equals the decrease in total surplus Overproduction Microeconomics Midterm 1 Study Guide Again, the efficient quantity is 10,000 pizzas per day. If production is expanded to 15,000 a day, a deadweight loss arises from overproduction Sources of Market Failure In competitive markets, underproduction or overproduction arise when there are o Price and quantity regulations o Taxes and subsidies o Externalities o Public goods and common resources o Monopoly o High transaction costs Price and Quantity Regulations Price regulations sometimes put a block on the price adjustments and lead to underproduction Quantity regulations that limit the amount that a farm is permitted to produce also lead to underproduction Taxes and Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers o So taxes decrease the quantity produced and lead to underproduction Subsidies lower the prices paid by buyers and increase the prices received by sellers o So subsidies increase the quantity produced and lead to overproduction Externalities An externality is a cost or benefit that affects someone other than the seller or the buyer of a good An electric utility crates an external cost by burning coal that creates acid rain o The utility doesn’t consider this cost when it chooses the quantity of power to produce. Overproduction results An apartment owner would provide an external benefit if she installed a smoke detector o But she doesn’t consider her neighbor’s marginal benefit and decides not to install a smoke detector. Underproduction results Public Goods and Common Resources Microeconomics Midterm 1 Study Guide A public good benefits everyone and no one can be excluded from its benefits It is in everyone’s self-interest to avoid paying for a public good (free-rider problem) which leads to underproduction A common resource is owned by no one but can be used by everyone o It is in everyone’s self-interest to ignore the costs of their own use of a common resource that fall on others (tragedy of the commons which leads to overproduction Monopoly A monopoly is a firm that is the sole provider of a good or service The self-interest of a monopoly is to maximize its profit. It sets a price to achieve its self-interested goal As a result, a monopoly produces too little and underproduction results High Transactions Costs Transactions costs are the opportunity cost of making trades in a market. To use the market price as the allocator of scarce resources, it must be worth bearing the opportunity cost of establishing a market. Some markets are just too costly to operate. When transactions costs are high, the market might underproduce. Information gathering about hard-to-observe quality can lead to high transactions costs Is the Competitive Market Fair? Ideas about fairness can be divided into two groups: It’s not fair if the result isn’t fair It’s not fair if the rules aren’t fair It’s not fair if the result isn’t fair The idea that only equality brings efficiency is called utilitarianism. Utilitarianism is the principle that states that we should strive to achieve “the greatest happiness for the greatest number.” If everyone gets the same marginal utility from a given amount of income, and if the marginal benefit of income decreases as income increases, then taking a dollar from a richer person and giving it to a poorer person increases the total benefit. Only when income is equally distributed has the greatest happiness been achieved. Microeconomics Midterm 1 Study Guide The Big Tradeoff Utilitarianism ignores the cost of making income transfers. Recognizing these costs leads to the big tradeoff between efficiency and fairness. Because of the big tradeoff, John Rawls proposed that income should be redistributed to the point at which the poorest person is as well off as possible. It’s Not Fair If the Rules Aren’t Fair The idea that “it’s not fair if the rules aren’t fair” is based on the symmetry principle. The symmetry principle is the requirement that people in similar situations be treated similarly. FOR A MORE COMPLETE STUDY GUIDE, PLEASE EMAIL ME AT firstname.lastname@example.org Thanks and good luck
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'