ECON 2106H Exam 1 Study Guide
ECON 2106H Exam 1 Study Guide Econ 2106H-2
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This 14 page Study Guide was uploaded by Danielle Fay on Tuesday September 20, 2016. The Study Guide belongs to Econ 2106H-2 at University of Georgia taught by Meghan M. Skira in Fall 2016. Since its upload, it has received 9 views. For similar materials see Principles of Microeconomics H in Economics at University of Georgia.
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Date Created: 09/20/16
ECON 2106H Exam 1 Study Guide Important terms Important concepts/phrases Economics: A social science which studies how society manages and allocates its scarce resources Micro vs Macro (micro directly affects macro) Micro - how households/individuals/firms make decisions and interact in market Macro - the forces and trends that affect the economy as a whole “Thinking like an economist” 1. People face tradeoffs 2. Opportunity costs are what must be given up to obtain some item or engage in some activity 3. People make decisions by comparing marginal costs and benefits 4. Economists believe people change behavior in response to incentives Efficiency: society gets the most it can from its scarce resources Equity: benefits of those resources are distributed fairly among members of society Marginal change: small, incremental adjustments to an existing plan of action PPFs - Production Possibilities Frontier: Graph that shows combinations of output that the economy can possibly produce given available factors of production and available production Opportunity cost of good x is high when good x production is high because producing another good x means moving some good y workers out of good y production, resulting in a substantial loss in good y production. Classifying Points Feasible: On/inside PPF (a & c) Infeasible: Outside PPF (b) Efficient: On PPF (a) Inefficient: Inside PPF (c) Note: PPF is bowed out when some workers are bette r suited to make good x and some good y. This makes opportunity costs NO LONGER CONSTANT Calculating Opportunity Costs Ex: Economy has 10 mil workers and produces 2 goods: Pizza and burritos. In 1 day, a worker can produce EITHER 2 pizzas or 10 burritos • Economy is currently making 10 mil pizzas and 50 mil burritos • Wants to increase pizza production to 12 mil o Burrito production decreases to 40 mil • What is the opportunity cost of increasing pizza by 2 mil? o 10 mil burritos • What is the opportunity cost of eac h pizza? o 5 burritos The relationship between opportunity costs are reciprocals! The absolute value of the slope at any given point on PPF = opportunity cost of good on x axis in terms of good on y axis (in this example, the slope of the PPF is ⅕, the opportunity cost of 1 burrito) The opportunity cost is constant when PPF is linear Note: If PPF is shifted, slope and opportunity costs remain the same Interdependence People can either • Be self sufficient • Specialize and trade People are better off when they specialize Patterns of production and trade are based upon differences in opportunity costs TRADE INCREASES ECONOMIC GAIN Absolute Advantage: The ability to produce a good using fewer inputs than another producer/the ability to produce more of a good than another producer using the same resources Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer Gains from Trade: Ex: In 1 hour drake can make 1c of lemonade or 4 grey sweaters, working 10hrs/day. In 1 hour, Beyonce can make 3c of lemonade or 6 grey sweaters, working 10 hrs/day • Drake is producing and consuming 5 lemonades and 20 sweaters (w/o tr ade) • Beyonce is producing and consuming 15 lemonades and 30 sweaters (w/o trade) • Proposal: Drake spends 10 hrs making sweaters and Bey spends 2 hours making sweaters and 8 hours making lemonade, then they trade. Drake Beyonce Lemonade Grey Sweaters Lemonade Grey Sweaters Production/ 5 20 15 30 Consumption w/o trade Production w/trade 0 40 24 12 Trade +8 -19 -8 +19 Consumption 8 21 16 31 Gains +3 +1 +1 +1 Trade allows producers to consume outside their PPF’s B&D’s opportunity costs 1 Lemonade 1 Grey Sweater D 4 GS ¼ Lemonade B 2 GS ½ Lemonade We can see that Beyonce has the comparative advantage in lemonade Drake has the comparative advantage in grey sweaters • It is possible for one producer to have AA in both goods • It is NOT possible for one producer to have CA in both goods • It is possible for neither producer to have CA (when OC are equal) ******GAINS FROM SPECIALIZATION AND TRADE ARE BASED ON COMPARATIVE****** ********ADVANTAGE******** Price of Trade: • Drake gets 8 lem for 19 sweaters, each lem costs 2.38 sweaters (opposed to 4 sweaters before) • Bey gets 19 sweaters for 8 lem, each sweater costs .42 lem (opposed to .5 before) International Trade Imports: goods produced abroad and sold domestically • We import from China, Mexico, Canada, Japan, Germany Exports: Goods produced domestically and sold abroad • We export to Canada, Mexico, China, Japan, UK Each country should specialize in and export the good in which they have a comparative advantage Through trade, countries can have more of all goods to consume Supply and Demand Market: A group of buyers and sellers of a particular good or service Perfectly Competitive Market: A market in which there are so many buyers and sellers that each has a negligible impact on the market place and goods for sale are all the same Monopoly: Only one seller with many buyers Demand Quantity Demanded: amount of goods buyers are willing and able to purchase Law of Demand: all other things equal, when the price of a good rises, the quantity demanded falls (and vice versa) Demand Schedule: A table that shows the relationship between the price of a good and the quantity demanded Demand Curve: The line relating price and quantity demanded To find total quantity demanded at any price, we add up individual quantities Shifts in demand curve “Increase in demand” - Increase in Qd at every price point; shift right “Decrease in demand” - Decrease in Qd at every price point; shift left Demand curves shift for: • Income change • Price changes of related goods • Taste changes • Expectations • Number of buyers A change in the price of the good causes movement along demand curve • Income change: • Normal Good: A good for which, all other things equal, an increase (decrease) in income leads to an increase (decrease) in demand (shift right) • Inferior Good: A good for which, all other things equal, an increase (decrease) in income leads to a decrease (increase) in demand (shift left) • Price of related goods • Substitutes: Two goods for which an increase in the price of one good leads to an increase in the demand for the other (Ex: coke & pepsi) • Complements: Two goods for which an increase in the price of one good leads to an decrease in the demand for the other (Ex: Peanut butter & Jelly) Supply Quantity supplied: The amount of a good sellers are willing and ab le to supply (mainly determined by price) Law of Supply: Other things equal, when price rises, quantity supplied rises, when price falls, quantity supplied falls Supply Schedule: A table that shows the relationship between the price of a good and the quantity supplied Supply Curve: The line relating price and quantity supplied Shifts in Supply Curve “Increase in supply” - Increase in quantity supplied at every price; shift right “Decrease in supply” - Decrease in quantity supplied at every price; shift le ft Supply curves shift for: • Input prices • Technology • Number of sellers • Expectations • Input prices • When input prices increase, producing the good is less profitable and supply decreases (shift left) • Technology • If technology improves and reduces amount of inputs needed to make the good, this reduces costs and increases supply (shift right) Equilibrium • A situation in which the market price has reached the level where Qs exactly equals Qd Law of supply and dema nd: Price of any good adjusts to bring supply and demand for that good into balance Changes in Equilibrium 1. Decide whether the event shifts supply or demand (or both) 2. Decide which direction the curve(s) shift 3. Use supply and demand graph to see how Q* and P* change Prices serve as signals to guide the allocation of scarce resources Elasticities -Measure of responsiveness of Qd or Qs to any one of its determinants Price Elasticity of Demand • The responsiveness of Qd to a change in price of that good • D is elastic when Qd responds substantially to price changes • D is inelastic when Qd responds only slightly to price changes • Determinants of elasticity: • Availability of a close substitute: more substitutes a good has, the more elastic the demand is • Necessity vs. Luxury: Necessities are more inelastic • Definition of market: Narrowly defined markets have more elastic demand • Time horizon: goods tend to have more elastic demand over a long period of time Calculating: Classification When |Ed| > 1, D is elastic When |Ed| < 1, D is inelastic When |Ed| = 1, D is unit elastic Elastic demand has a substantial change in Qd in response to a price change Inelastic demand does not have a substantial change in Qd in response to a price change Extreme Cases Ed=0, D is perfectly inelastic Change in price has NO effect on quantity demanded (Ex: Insulin) |Ed| = Infinity, D is perfectly inelastic If price rises above p*, Qd drops to 0. If price drops below p*, Qd becomes infinity. At p*, consumers are indifferent In linear demand curve, slope is constant but Ed IS NOT TR IS MAXIMIZED AT THE MIDPOINT ON A LINEAR DEMAND CURVE Total Revenue Total Revenue: Amount of money received by sellers of a good = P x Q If D is inelastic, %ΔQd<ΔP • If P increases, Qd decreases, and TR increases • If P decreases, Qd increases, and TR decreases If D is elastic, %ΔQd>%ΔP • If P increases, Qd decreases, and TR decreases • If P decreases, Qd increases, and TR increases If D is unit elastic, %ΔQd>%ΔP • If P increases, Qd decreases, TR remains the same • If P decreases, Qd increases, TR remains the same General Rule: When D is elastic, price and TR move together. When D is elastic, p rice and TR move oppositely, when D is unit elastic, TR is constant Income Elasticity of Demand • Measure of responsiveness of Qd to change in consumers income • For normal goods, Ei>0 • For inferior goods, Ei<0 Cross Price Elasticity of Demand • Measure of responsiveness of Qd to change in price of another goo d • For substitutes, Ex>0 • For complements, Ex<0 Ex: 1% increase in price of Marta, there is a .5% increase in Qd taxis Price Elasticity of Supply • Measure of responsiveness of Qs to change in price of the good • If Es>1, S is elastic • If Es<1, S in inelastic • If Es=0, S is perfectly inelastic Welfare Economics • Studies how the allocation of resources affects economic well being (of consumers and producers) Consumer Surplus Willingness to Pay : Max amount a buyer will pay for a service/good Consumer Surplus: Amount a buyer is willing to pay minus the amount actually paid Any quantity given by D curve reflects the Willingness to pay of marginal buyer When price falls, consumer surplus increases because there are new buyers in the market and a larger gap between price and willingness to pay Producer Surplus Producer Surplus: Amount seller is paid minus cost of providing the good At any quantity, the price given by supply curve represents cost of the marginal seller When price increases, producer surplus increases because there are new sellers and a larger gap between price and opportunity cost Total Surplus CS+PS=TS Efficiency: total surplus is maximized Equality: Distributing economic prosperity uniformly to members of society At market equilibrium, TS is maximized Market equilibrium is efficient if: 1. Market is perfectly competitive 2. Rational agents 3. No externalities CS=(½)(Q*)(y intercept D curve -P*) PS=(½)(Q*)(P*-y intercept S curve) Price Controls • Price Ceiling: Set legal max on price • Price Floor: sets legal min on price Price Ceiling 2 Possibilities: 1. Ceiling > P* → nonbinding (no effect on market) 2. Ceiling < P* → binding (creates shortage) Price Floor 2 Possibilities: 1. Floor < P* → Nonbinding (no effect on market) 2. Floor>P* → Binding (creates surplus) Taxation Tax incidence: How burden of tax is shared among buyers and sellers Tax levied on buyers and sellers are EQUAL In equilibrium, buyers and sellers share the burden of tax With taxes, there is still an equilib rium Wedge Method Move to left of original equilibrium until there is a wedge between S and D curves with a length the size of the tax. It does not matter WHO the tax is imposed on Ex: - Before tax: Qd = 300-P Qs = 2P Q* = 200 P* = $100 - Tax imposed of $6 t = $6 Pc = Ps+6 Qd = 300-Pc = 300-(Ps+6) Qs = 2Ps Pc = $104 Ps = $98 Qt = 196 Tax incidence: Pc-P*, $104 - $100 = $4 P* - S, $100 - $98 = $2 Tax Incidence & Elasticity What matters is relative price elasticity of supply and demand 1. When market has elastic supply and inelastic demand, buyers bear most of the burden 2. When market has elastic demand and inelastic supply, sellers bear most of the burde Tax burden falls more heavily on the side of the market that is less elastic (more inelastic) → side that is less elastic (more inelastic) is less willing to leave the market When do buyers bear the full burden of tax? -When supply is perfectly elastic or demand is perfectly inelastic When do sellers bear the full burden of tax? -When demand is perfectly elastic or supply is perfectly inelastic Taxation and Welfare Economics 3rd party is now being affected: Government revenue = t x Q*t Redefine Total surplus = CS + PS +GR No tax Tax Change CS A+B+C A -(B+C) PS D+E+F F -(D+E) GR 0 B+D +(B+D) TS A+B+C+D+E+A+F+B+-(C+E) Deadweight loss: Fall in total surplus resulting from a market distortion (ie. taxes, floors, ceilings) Why do taxes cause DWL? -Q bought and sold declines -Trade that would be beneficial to buyers and sellers do not take place → For output between Q* & Q*t the value to consumers is larger than the cost to produce those units, but those units don’t get produced! ):
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