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ECON 200 Study Guide Midterm 10/6

by: Lucy Notetaker

ECON 200 Study Guide Midterm 10/6 ECON 200

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Lucy Notetaker

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This study guide covers Chapter 1, 3-6 I used both notes from the textbook and class notes to pull this together
Principles of Economics: Microeconomics
Dr. Robert Schwab
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This 8 page Study Guide was uploaded by Lucy Notetaker on Tuesday September 27, 2016. The Study Guide belongs to ECON 200 at University of Maryland taught by Dr. Robert Schwab in Fall 2016. Since its upload, it has received 505 views. For similar materials see Principles of Economics: Microeconomics in Economics at University of Maryland.


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Date Created: 09/27/16
ECON 200 Study Guide: Chapter 1, 3-6 Chapter 1 This chapter is extremely basic. I’m going to cover it briefly. Economics- The study of how people manage resources - Microeconomics (our course) is the study of how individuals and firms manage the resources Rational Behavior- Making choices to achieve goals in the most effective way possible - Economists assume that people make decisions rationally - Involves comparing additional benefits with additional costs - Four Questions that contribute to rational decisions 1. What are the wants and constraints? (Scarcity involves wanting more than what your resources allow) 2. What are the trade-offs (Opportunity Cost- the value of your next best alternative) 3. How will others respond? (Incentives- something that causes people to behave a certain way by changing their trade-offs) 4. Why isn’t everyone already doing it? (Innovation, Market Failure, Intervention, Goals other than profit) - Rational decisions involves marginal decision making Marginal Decision Making - Also called thinking at the margin - Marginal Change: a small incremental change to a plan of action (making one more iPhone, eating one more Pringle) - Example: You are at an amusement park and you paid $20 to enter. Each roller coaster you ride costs an additional $5. You should make the decision to ride a second or third time based off of only the $5 price tag. If you would enjoy going on the ride for a second time and it’s worth the $5 extra to you, go for it. Do not even look at the $20 or try to “make up for it” by going on more roller coasters. This is a sunk cost and should not be factored into your decision to ride. - Sunk Cost- a cost that has already been committed and can not be recovered ECON Tool Box 1. Correlation and Causation- an observed relationship between two variables vs. a relationship between two events in which one brings about the other *Correlation does not necessarily mean causation 2. Models- Circular Flow Model is a big one. It shows the relationship between households and firms. The households provide employees, firms provide goods and households consume the goods. It shows the flow of goods, services, and money 3. Positive vs. Normative Facts- A positive statement is one based in fact, while a normative claim is one based in opinion about “how the world should be” Chapter 3 Arguably, I’d say this is the most important chapter, because supply and demand are everything in this course Opportunity Cost- The value of what you have to give up in order to get something (your next best alternative) - The better your second choice is the higher the opportunity cost - Example: You’re going to work and you have the choice to pay $5 and take the bus or walk (which is free). If you take the bus then your opportunity cost is the benefit and money saving you get from walking. If you walk then you’re opportunity cost is avoiding sweat from taking the bus. - Example 2: You are offered one million dollars, but to claim it you have to kill a child (sorry this one is morbid). If you take the money (darn business majors :P *it’s ok, I am one) then the opportunity cost is the child’s life. If you refuse the money then the opportunity cost is one million dollars. Components of a Competitive Market 1. Standardized Goods- two units have the same features and are interchangeable (iPhone cases from different brands all fit the iPhone) 2. Full information about what they are buying 3. No transaction costs 4. Price Taker- a buyer or seller can not affect the market price Demand- how much of something people are willing to buy under certain circumstances - Price changes affect quantity demanded (movement along curve) - Non price determinants (listed below) shift demand 1. Consumer Preferences (choosing a hamburger vs. a hot dog) 2. Prices of Related Goods (if mittens are cheaper than gloves, then glove demand will go down) - Complements- goods in which demand will rise and fall with a partner good (if jelly demand goes down, so will peanut butter) - Substitutes- goods that can replace each other due to a similar purpose (Toast can replace bagels if bagel price skyrockets) 3. Incomes - Normal Goods: As income increases, demand for these goes up (typically the case) - Inferior Goods: As income increase, demand goes down (broke college students buying cups of Ramen) 4. Expectations (do customers expect prices to go up or down?) Quick Notes about Demand - When demand decreases, the entire demand curve shifts left and vice versa for an increase - Demand and Quantity demanded are not the same thing…I can’t stress this enough Supply- how much of a good or service producers will offer for sale under a given circumstance - Quantity supplied will go up as price increases (the more you are receiving for a good, the more you will want to supply it) - The non price determinants for supply are...(these will shift the entire supply curve 1. Price of related goods 2. Technology- In class, he mentioned Fracking, which is drilling and injecting liquid into crude oil. This is a technological change that will shift supply to the right 3. Price of Inputs 4. Expectations 5. Number of Sellers (more sellers mean each seller supplies less) Quick Notes - Decreases in supply or increases in supply means the entire curve moves either left or right. Quantity supplied means that price is causing a movement along the curve (sorry for being repetitive, this is just a very important distinction) Equilibrium- the situation in the market when the quantity supplied equals the quantity demanded - There will always be an equilibrium quantity (x value) and equilibrium price (y- value) - This is the “perfect” situation if you will - Surplus- when quantity supplied is higher than quantity demanded - Shortage- when quantity demanded is higher than quantity supplied Relationships - If demand shifts then supply will not move, but EPrice and EQuantity will change - If supply shift then demand will stay, but EPrice and EQuantity will change - Demand and supply both decrease (EP unknown, EQ goes down) - Demand and supply both increase (EP unknown, EQ goes up) - Demand decreases and supply increases (EP goes down, EQ unknown) - Demand increase and supply decreases (EP goes up, EQ unknown) Class Additions - Surge pricing- a quick increase in price due to an increase in demand. There’s a massive snowstorm, so price of shovels double - Arbitrage- an investment that has zero risk a. Stock Exchanges- if prices are different for same stock in a different markets, buy from one and sell in the other b. IOWA electronic market- If the price of an individual candidate is lower/higher than $1 (bundle price) c. Global Market- This one was crazy, but basically if you look at exchange rates and what each currency means to each person, there could be an opportunity in there for arbitrage Chapter 4 Elasticity- a measure of how much consumers and producers will respond to a change in market conditions Price Elasticity of Demand- the size of the change in quantity demanded of a good or service when its price changes - An elastic product is sensitive to price change, but inelastic products are not - The formula is PE=%change in quantity demanded/%change in price - % change= Q2-Q1/Q1 multiply by 100 - for price, take the above formula and put in p - The answer should be negative - The Midpoint Method- [(Q2-Q1)/((Q1+Q2)/2)]/[(P2-P1)/ ((P2+P1)/2)] - Benefit of midpoint is it’s consistent no matter which way you go - Determinants of Demand Price Elasticity a. Availability of Substitutes b. Degree of Necessity c. Cost Relative to Income d. Adjustment Time e. Scope of the Market Spectrum of Elasticity 1. Perfectly Elastic- horizontal line, quantity drops to 0 if price increases 2. Elastic- Percent price change is less than change in quantity demanded 3. Unit Elastic- Percent price change is equal to quantity change (1) 4. Inelastic- Percent price change is greater than quantity change 5. Perfectly Inelastic- vertical line, quantity demanded is the same at every price Total Revenue- the amount a firm receives from the sale of goods and services - It is TR=Quantity sold multiplied by price paid for each unit - Price Effect: Raise prices and higher price means more revenue - Quantity Effect: Increase in price leads to a decrease in revenue because you sell fewer units - Net Effect: It is ambiguous (when you look at both price and quantity effect), but it depends on the elasticity of the product Price Elasticity of Supply- the size of the change in the quantity supplied of a good or service when price changes - Use the exact same formulas as demand elasticity - This time, you should expect a positive number - Determinants of Price Elasticity of Supply a. Availability of Inputs b. Flexibility and the Production Process c. Adjustment Time (longer the time period, the more elastic supply is) Cross Price Elasticity of Demand- a measure of how the quantity demanded of one good changes when the price of a different good changes - CPED=% change in quantity demanded for A/% change in price B - Substitutes will have a positive answer, complements will be negative (the farther the number is from 0, the stronger the complement or substitute) Income Elasticity of Demand- a measure of how much the quantity demanded changes in response to a change in consumer income - IED=%change in quantity demanded/% change in income - Luxury Goods will be more elastic - Inferior goods will have a negative answer Chapter 5 How’s everyone doing? We’re almost done  Welfare Economics- the allocations of resources affects the economies well being - This chapter is about how awesome markets are (first definition was a random thing he said in class so I decided to open with it) Willingness to Pay- the maximum price that a buyer is willing to pay for a good or service (reservation price) - Consumer Surplus- If the consumer gets a good for less than the reservation price, it’s the difference between reservation price and actual price - The consumer surplus will be the area under the demand curve, but above equilibrium Willingness to Sell- a minimum price that a seller is willing to accept for a good or service - Producer Surplus- If the producer sells for more than the minimum price it’s the difference between expected price and actual price - The producer surplus will be above the supply curve, but under equilibrium Total Surplus- a measure of the combines benefits that everyone receives from participating in an exchange - It is consumer surplus + producer surplus Deadweight Loss- a loss of total surplus that occurs because the quantity of a good that is bought and sold is below market equilibrium quantity (he said not to worry about this, but it’s good to keep in the back of your mind) - To calculate it is Total surplus at equilibrium (before intervention)- total surplus after intervention Missing Market- when there is desire to sell or buy, but no venue (black market? As an example) Chapter 6 This is the end, guys! Last Chapter! Why Should the Government Get Involved? 1. Correcting Market Failures (monopolies, heavy air pollution, greenhouse gases) 2. Changing the Distribution of Surplus (income equality and reducing poverty) 3. Encouraging or discouraging consumption (a tax on cigarettes) Price Controls- a regulation that sets a minimum or maximum legal price for a particular good - Price Ceiling: a maximum legal price at which a good can be sold (doctor care) - Can be bad if ceiling is below equilibrium (excess demand) - But will have no affect if it is above the equilibrium price - Price Floor: a minimum legal price at which a good can be sold (milk) - If price floor is above equilibrium price, there will be an excess supply - If price floor is below equilibrium price it will not affect the market The Kidney Example from Class - The kidney donation process is a price ceiling because you can not sell organs - Demand is perfectly inelastic, and supply still exists even at a price of 0, so the graph is funky Quantity Control- when the government says that a firm can only produce so much of a good - Once the quantity is reached the curve becomes a vertical line (price increases) - Taxi cab example: NYC only allows 60 taxi cabs (before uber)price increases and extremely high cost for license/badge Tax- a cost imposed on either buyers or sellers to raise revenue for the government - They discourage consumption and raise revenue - Whoever the tax is imposed on (seller or buyer) will have a decrease in the curve while the other curve stays the same - A tax on buyers will cause both equilibrium price and quantity to fall, but if the ta is on sellers, the price will rise and quantity will fall - Government Tax Revenue= Tax * Equilibrium Quantity (post tax) Tax Wedge- the difference between a price paid by buyers and price received by sellers - To calculate TW= $paid from buyers-$ received by sellers Tax Incidence- the relative tax burden borne by buyers and sellers - Typically the consumer will bear the burden, because they pay more - But, the more elastic a good is, the less the consumer will suffer - Basically, whichever side is more elastic will suffer less 4 Effects of Taxes 1. Equilibrium Quantity falls 2. Buyers pay more and sellers receive less 3. The government raises revenue 4. Tax causes a deadweight loss, reduction in total surplus is always larger than gov revenue Subsidies- a requirement that the government pay an extra amount to consumers or producers of a good - The general guidelines of what will occur are a. Equilibrium quantity will increase b. Buyers pay less and sellers receive more c. Government pays for the subsidy - For c, the equation is Subsidy Price=amount of subsidy * New equilibrium quantity - Typically speaking, subsidies are given to the sellers Payday Loans- small amount loaned (under $500) and they are due on your next payday - It gives the lender access to your checking account - Extremely high interest rates - Involves renewals and rollovers- if you can’t pay the loan, they give you a new loan, but the catch is that it includes interest from the first loan - The borrower can easily get trapped - Bureau of Consumer Financial Protection (CFP) a. Lender must verify that borrower can indeed pay loan b. Restrictions on number of loans a lender can make to a borrower in a specific time period c. Some want a limit on the interest rates Okay guys, so that’s midterm #1. I just want to say a quick thank you to everyone who has purchased notes, given me feedback or has downloaded thithstudy guide. Your support means everything! Good luck on the 6 . If you want to study with me or have any questions about any of my notes, feel free to email me at


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