ECON 2020 (Dr. Macy Finck) Exam 2 Study Guide
ECON 2020 (Dr. Macy Finck) Exam 2 Study Guide Econ 2020
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This 16 page Study Guide was uploaded by Gabrielle Ingros on Tuesday September 20, 2016. The Study Guide belongs to Econ 2020 at Auburn University taught by William M. Finck in Fall 2016. Since its upload, it has received 121 views. For similar materials see Principles of Economics: Microeconomics in Economics at Auburn University.
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Date Created: 09/20/16
ECON 2020 EXAM 2 Lecture 1: Production Possibilities Frontier • Production Possibilities Frontier (PPF) – curve that graphs all possible combinations of two given goods that an economy can produce o Assumptions: § A single economy produces only two goods § The quantity of resources is fixed § Technology is fixed § Resources are identical (applies to example #1 only) • Constant Opportunity Cost Graph: o Either catch 5 fish OR collect 45 coconuts o Capable of producing any combination of fish and coconuts that falls inside the PPF line § A = represents inefficient (unemployment) § B = (better than A) because it is on the line (represents efficient – full employment) • The only way to get more fish is move people from coconut to fish § C = represents unattainable (given our a ssumptions) o The goal is to make the unattainable attainable o Note: We can measure changes in unemployment as the production point moves § A to B = decrease in unemployment ECON 2020 EXAM 2 § B to A = increase in unemployment (probably in a recession) • (*On test be able to explain Movement of production point relative to the PPF) o Note: once full employment is attained, the only way to increase the production of one good is to take resources away from the other good § Essentially you are calculating th e slope of the line • Efficient Combinations Table #1: Fish 0 1 2 3 4 5 Coconuts 45 36 27 18 9 0 Opportunity Cost of a Fish --- 9C 9C 9C 9C 9C th • Opportunity Cost of N unit of X = Quantity of Y at n -1 – Quantity of Y at n o (i.e. gave up 9C to produce 1 fish [45 coconuts – 36 coconuts = 9], then 9C to produce 2 fish [36 coconuts – 27 coconuts = 9], and so on…) § These numbers are the same because the PPF line is a straight line, it is constant • Law of Increasing Opportunity Cost – as production of a good increases, the opportunity cost of producing an additional unit rises o Opportunity Cost: number of units of the other good given up • Efficient Combinations Table #2 Fish 0 1 2 3 4 5 Coconuts 45 42 36 27 15 0 Opportunity Cost --- 3C 6C 9C 12C 15C of a Fish o The opportunity cost should either remain the same or should be increasing (it will never decrease) • Increasing Opportunity Cost Graph: ECON 2020 EXAM 2 o This allows us to reach point C (point C is now attainable and efficient) o Point D is only attainable through Economic Growth or Trade § Economic Growth allows us to produce more stuff (when supply shifts to the right) • Economic Growth: o An outward shift of the PPF § Causes: • An increase in the supply of resources • A technological Improvement • A change in regulation o Through economic growth we can produce bundle D o Through trade we can consume bundle D without a PPF shift Lecture 2: Trade Markets • Two tables represent two economies: o Every time we work a trade problem, the opportunity cost will be constant so you only need the two end points ECON 2020 EXAM 2 • Trade: Fish Coconuts Them 10 20 Us 12 48 o They will produce 10 fish OR 20 coconuts o We will produce 12 fish OR 48 coconuts • Absolute Advantage – the ability to produce more in a given time frame o Which economy should produce each good? • Comparative Advantage – the ability to produce at a lower marginal (additional) opportunity cost Fish Coconuts Opportunity Cost Opportunity Cost of a Fish of a Coconut Them 10 20 2C ½F Us 12 48 4C ¼ F • Opportunity Cost of Good X = Quantity of Y/Quantity of X o They: 20/10 = give up 2C every time they produce 1 fish § Give up ½ fish every time they produce 1 coconut o Us: 48/12 = give up 4C every time we produce 1 fish § Give up ¼ fish every time we produce 1 coconut • The Comparative Advantages will always be split between two markets o So let them produce fish and we will produce coconuts ( choose the lower opportunity cost to determine who produces what ) • Drawing Graph of above tables – Production: assume that the economies completely specialize according to their comparative advantage o P = production o Production (write down coordinates ): Them = (10F, 0C) and Us: (0F, 48C) • Production and Consumption : • GIVEN: o Assume that the economies agree to trade 3 coconuts for each fish traded o Assume that the fish -producing economy is willing to trade 4 fish for coconuts § How much of each good will each economy p roduce and consume? o Production: § Them: 10 fish and 0 coconuts § Us: 0 fish and 48 coconuts o Trade: ECON 2020 EXAM 2 § They export (we import) 4 fish § We export (they import) 12 coconuts o Consumption: § Them: produce 10 fish – send 4 fish = 6 fish § Them: produce 0 coconuts + import 12 coconuts = 12 coconuts • Them: 6 fish and 12 coconuts § Us: produce 0 fish + import 4 fish = 4 fish § Us: produce 48 coconuts – 12 coconuts = 36 coconuts • Us: 4 fish and 36 coconuts § Add these numbers back together to check if correct • i.e. (them: 6 fish + us: 4 fish = 10 fish) • i.e. (them: 12 coconuts + us: 36 coconuts = 48 coconuts) • Back to graph: • Consumption: o Them: 6 fish and 12 coconuts o Us: 4 fish and 36 coconuts • Example #2 o Goods are grits and shrimp o This economy is producing 60 grits and 0 shrimp § Production: 60 grits and 0 shrimp § Consumption: 30 grits and 15 shrimp • Exports = production – consumption o Exports: 60 -30 = 30 grits • Imports = consumption – production o Imports: 15 – 0 = 15 shrimp • Terms of Trade for Import = export/import ECON 2020 EXAM 2 o 2 grits : 1 shrimp • International trade arises primarily from Comparative Advantage • If we have a Comparative Advantage in production, we will export the good. If not, we will import the good. Lecture 3: International Trade Markets • Export Markets Graph: o Sd = supply domestic & Qd = demand domestic o Pn = no-price equilibrium & Qn = no-trade equilibrium • When the market opens to free trade, international consumers are added to demand o Dw = world demand & Pw = world price & Qs = domestic production o Qd = domestic consumption • Note: identify this market as an export market (because there is world demand and the world price is higher than the no -price) ECON 2020 EXAM 2 • Note: identify the number of units that are being exported • Note: identify the changes in social welfare by measuring changes in consumer and producer surplus o Subtract B from C • US exports = Qs – Qd • Lost consumer surplus = Pw,A,C,Pn (“upside down boat”) • Gained Producer surplus = Pw,B,C,Pn (“right side up boat”) ECON 2020 EXAM 2 • Net welfare gain = A,B,C o Consumers are worse off, but producers are so well off that the net welfare gain still increases (“the pie is getting bigger”) • Import Markets Graph: o Pn = no-price equilibrium & Qn = no-trade equilibrium o When the market opens to free trade, international producers are added to supply o US Imports = Qd – Qs ECON 2020 EXAM 2 o Qd = domestic consumption • Identify as import market (world supply and the world price is lower than the no-price) o Lost Producer Surplus = Pn,A,C,Pw o Gained Consumer Surplus = Pn,A,B,Pw ECON 2020 EXAM 2 o Net Welfare Gain = A,B,C • Types of Trade Restrictions : o Tariff – a tax levied on goods imported into a county o Import Quota – a specific limit or maximum quantity of a good permitted to be imported into a country during a given period • Impact of a Tariff graph: o Pw + t = world price plus tariff o Pre-tariff imports = Qd – Qs ECON 2020 EXAM 2 o Post-Tariff imports = Qd1 – Qs1 o Number of imports is shrinking (blue line to pink line) o A = gained producer surplus ( much smaller than lost consumer surplus ) • The government is now earning T on every unit imported into this market (tax x imports) o B = gained tax revenue ECON 2020 EXAM 2 o C = deadweight loss (how much worse off we are as a society when a tariff is placed on the import market) • How many units imported before tariff? (blue) How many after? (pink) o Value of Tariff = (Pw + t) – (Pw) = T • Tariff vs. Quota: o Import quotas have a similar impact, except area B goes to foreign producers rather than the U.S. government o With tariffs, foreign producers with the lowest costs will import the most o With quotas, only foreign producers with permission may import, regardless of costs Lecture 4: Elasticity • Elasticity – a measure of the relative responsiveness of one variable to a change in another • Price Elasticity of Demand – the ratio of the percent change in the quantity demanded to the percent change in the price %∆▯▯ • ???????? = %∆▯ o Note: Ed is always negative, but just ignore the negative sign ∆▯▯ • %∆???????? = ▯▯▯▯▯▯▯▯ ▯▯ • %∆???? = ∆▯ ▯▯▯▯▯▯▯▯ ▯ o Convert to % by multiplying by 100 • Example: o When the price of a good has fallen from $10 to $8, the Qd increases from 200 to 250. Find Ed. § %ΔQd = (250 – 200)/200 = .25 § %ΔP = (10 – 8)/10 = .2 § Ed = .25/.2 = 1.25 • Midpoint Formula: ▯▯▯▯▯ ∆▯▯ (▯▯▯▯▯) ▯▯▯.▯▯ ▯ • ???????????????????????????????? ???????????????????????????? = ∆▯ = ▯▯▯▯▯ ▯▯▯.▯ ▯▯▯▯▯ ▯ • Example #1 (Using numbers from previous example) : o Ed = (50/225)/(2/9) = .222/.222 = 1 • Example #2: ECON 2020 EXAM 2 o Ed = 1.2 o Qd = 100,000 o P = $0.50 § What is the ΔQd when ΔP is $0.05? o Solution: 1.2 = (ΔQd/100,000)/(.05/.50) = 1.2 = ΔQd/100,000 = 12,000 § So, ΔQd = 12,000 Units • Possible Elasticity Coefficients : o Perfectly Elastic – Ed = infinity (a tiny change in P causes an infinite change in Qd) o o Elastic – Ed > 1 (%ΔQd > %ΔP); flat o o Unit Elasticity – (%ΔQd = %ΔP) § Nothing really happens; boring o Inelastic – Ed < 1 (%ΔQd < %ΔP); steep ECON 2020 EXAM 2 § Sin Taxes – taxes on “bad” goods such as alcohol & cigarettes o Perfectly Inelastic – Ed = 0 (a huge change in P causes no change in Qd) Lecture 5: Elasticity • Determinants of Price Elasticity of Demand: o (1) Number of Substitutes – number of substitutes and elasticity move together o (2) Time in Which to Make the Purchase – time and elasticity move together o (3) Proportion of Income – proportion and elasticity move together (i.e. if your income decreases the elasticity increases because goods become a larger percent, “chunk” of your paycheck) o (4) Luxuries vs. Necessities – need and elasticity move opposite • Note: If you say you will still buy a good with a change of price – you are elastic, but if you say no – you are inelastic • Total Revenue and Price Elasticity : o Total Revenue – money earned from selling goods and services; NOT the same as profit, which includes costs § Total Revenue = P x Q o As P falls, Q rises, so what happens to Total Revenue? § It depends on elasticity (Left = Elastic & Right = Inelastic) ECON 2020 EXAM 2 • Example: o P1 = $1 Q1 = 150 P2 = $1.25 Q2 = 100 § Find Ed (using the Midpoint Formula) and ΔTR o Ed = ((150-100)/((150+100)/2))/((1.25 -1)/((1.25+1)/2)) = .4/.222 = 1.8 § Clearly, the total revenue falls o TR1 = 1 x 150 = $150 o TR2 = 1.25 x 100 = $125 § ΔTR = TR2 – TR1 = -$25 • Summary: o Ed > 1; price and TR move opposite o Ed < 1; price and TR move together o Ed = 1; a price change has no effect on TR • Price Elasticity Along a Linear Demand Curve : Price $10 $9 $8 $7 $6 $5 $4 $3 $2 $1 $0 Quantity 0 1 2 3 4 5 6 7 8 9 10 Total Revenue 0 9 16 21 24 25 24 21 16 9 0 As P falls, the TR rises: Elastic As P falls, the TR falls: Inelastic • Graph: ECON 2020 EXAM 2 o Elasticity decreases as quantity increases o At the Midpoint: Ed = 1 (TR is maximized ) • Other Types of Elasticities : o Price Elasticity of Supply: Es = %ΔQs / %ΔP § When S is inelastic, ΔD causes a big ΔPe § When S is elastic, ΔD causes a big ΔQe o Income Elasticity of Demand: Ei = %ΔQd / %Δincome § Ei is positive for normal goods § Ei is negative for inferior goods o Cross Elasticity of Demand: Exy = %ΔQd of X / %ΔP of Y § Exy is positive for substitutes § Exy is negative for complements
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