ECON 142 Study Guide for Test #2
Chapters 5, 6, and 7
NOTES FROM ALL LECTURES PERTAINING TO TEST 2
Equilibrium is also known as optimal and efficient.
Demand curve represents the benefit people see in this good. Supply curve represents costs associated with the good.
Market Failure: situation where the market, left on its own, fails to produce optimal level of output. This justifies government intervention.
A specific thing that is provided by the government, because the market gets it wrong.
A public good is both:
1. non-rival consumption - multiple people can consume the good. Unlike food, or many other items. (movie in a theater) 1 2. non-exclusion - you might pay for something and not get it, and you might not pay for something and still get it. (fishing in the ocean)
Common Resources (Fish in Ocean)
Quasi-Public Goods (Cable TV and Toll
Externalities (spill-over effect)
A cost or a benefit caused by a transaction that isn’t part of the
(A cost that affects someone that isn’t directly involved with the consumption of a good.)
positive externality: something you benefit from
Negative externality: something that costs you something We also discuss several other topics like disadvantages of narrowcasting
Social Costs = private costs + external costs. social cost is the amount shifted between private and external.
Social Benefit = private benefits + external benefits.
Supply curve represents private costs and demand curve represents private benefits!!!
INCORPORATE THE EXTERNALITY: SHIFT THE CURVE
Price Elasticity: RESPONSIVENESS
The bigger change in demand when price changes, the more elastic demand is.
If the price changes, and you buy the same amount you were going to buy anyway, you didn’t respond. Don't forget about the age old question of a journal of the plague year themes
Your demand is not responsive or elastic.
If price changes and you buy a little more or little less than what you were going to, then you were somewhat responsive and elastic.
If the price changes and you buy a lot more or a lot less, then you have a very responsive and very elastic demand.
We care because we can determine if we’ll make more money selling more units at lower price or lesser units at higher price. It’ll also determine how much margin/profit we’ll make on a product. Don't forget about the age old question of budgeted production needs are determined by
THINGS THAT MAKE A PRODUCT ELASTIC
1. number of substitutes (lot of substitutes=elastic)
2. luxury or necessity (luxury tends to be elastic)
3. how broadly the market is defined (broadly=elastic) for example, a flight to new york is broad. a flight to boston on a friday at five is narrow. Don't forget about the age old question of ast 104 syracuse
We also discuss several other topics like lawrence reitzer
4. size of good in consumer’s budget (large part of budget=elastic) 5. The amount of time one has to adjust to the price change
If demand is elastic and price is lowered, make more If demand elastic and price is raised, lose money If demand is inelastic and price is lowered, make less If demand is inelastic and price is raised, make more
Percent Change in Quantity Demanded
--------------------------------------------- = Price in Elasticity
Percent Change in Price
We can calculate elasticity if we know these 4 things:
1. original price
2. new price
3. original quantity demanded
4. new quantity demanded
change in quantity demanded
average quantity demanded We also discuss several other topics like university of houston kinesiology
change in price
If we get a number lower than 1, demand is inelastic.
Over 1 = elastic.
REMEMBER: Elasticity is not slope. Elasticity can change on the same demand curve, while slope can’t.
Cross Price Elasticity
∙ Two different goods.
∙ How does the quantity demanded of X change when the price of Y changes?
∙ If two goods are subs, cross price elasticity is positive. if they are complements, elasticity is negative.
As more time passes, supply becomes more ELASTIC
Income Elasticity of Demand
Necessity? Income elasticity is positive but small
Luxury? Income elasticity is positive and large
Inferior Good? Income elasticity is negative!
Combining Elasticity with imposing a tax
Elasticity of Supply
E of Supply + E of Demand
This is the percentage of any tax that will fall on the BUYER.
When Supply is on top, it falls on buyer.
When demand is on top, it falls on the seller.
The more elastic the supply is, the more of the tax falls on the buyer.
The more elastic demand is, the more of the tax falls on seller.
55% of people get health care from where they work
36% get through government:
Medicaid=poor people medicare=elderly
15% buy through the market
10% just go without it
KNOW THESE STATISTICS!
emergency rooms are required to treat acute cases
not required to treat chronic cases.
USA - Third Party Payer System - principal agent problems Canada - Single Payer System
UK - Socialized Medicine (doctor is gov employee)
ObamaCare is NOT socialized medicine.
Principal-agent problems: One party acting on behalf of another party… but there is asymmetric or incomplete info.
Agent pursues his/her own interests instead of the interests of the principal who hired him/her. This is the PROBLEM.
When one party to a transaction has less info than the other party.
Examples: buying a used car
enrolling in an econ class.
hiring a baby sitter
taking a cruise
markets function badly or not at all when info is incomplete markets function better when info is more complete
A role for government? Require more complete information
Hidden info. When one party takes advantage of another party’s lack of info.
Result: bad customers or bad products are more likely to be selected.
Sometimes seller has more info and can take advantage (taxi drivers) Sometimes buyer has more info and can take advantage (all types of insurance)
A way of reducing adverse selection in insurance. (States require all drivers to have insurance, not just reckless drivers.)
This ensures that the insured population represents the overall population.
∙ Insurance company chooses to insure 100 people.
∙ $100 a month, for a total of $36,000 total revenue
∙ Insurance company expects 5 of these people to need surgery ∙ Surgery costs 7000 each
∙ company spends 35,000, covers costs and makes a little money. BUT THIS IS IF THEY GUESS RIGHT
∙ If more need surgery, they are screwed.
∙ So company increases costs to make sure they don’t get screwed, and all 100 people have to pay more. that is risk pooling.
Hidden action/behavior. Actions you take after entering a transaction that take advantage of the other party’s lack of info.
When people change their behavior after they get insured. Rising cost of health care.
In 2013, it was 17.3% of GDP.
In 2019 it’s expected to be 19.6% of GDP.
The 3 reasons costs are rising:
“Cost disease” - service industries do not see productivity gains like manufacturing see. Low productivity in service industries causes higher costs…
The population is aging. Healthcare on old people is 6x greater than young people.
Distorted Economic Incentives The things we’ve just covered. (Adverse selection, moral hazard).
OBAMACARE IS NOT:
5. Socialized medicine
6. Single-payer system
a set of adjustments to our current system.
5 adjustments of OBAMACARE:
1. Individual mandate: you now have to have insurance, or pay a fine. (risk pooling)
2. Pre-Existing Conditions - Stops insurance companies from denying coverage to people because of pre-existing conditions
3. Employer Mandate: Requires all firms with more than 200 employees to offer insurance. Firms w/50-200 employees can offer insurance or pay a fee, small companies with less than 50 people are unaffected.
4. More people qualify for Medicaid: insurance given by government to poorer people. incomes>200,000=tax increase.
5. Young people can stay on parents insurance until 26 years old. 20 QUESTIONS FROM PAST EXAMS
1. You are the Pricing Manager for a product that is a small part of a consumer's budget and has relatively few substitutes. Your recommendation to your boss would be...
a. Lower the price of this good if you want to increase revenues because the demand is most likely elastic
b. Lower the price of this good if you want to increase revenues because the demand is most likely inelastic
c. Increase the price of this good if you want to increase revenues because the demand is most likely elastic
d. Increase the price of this good if you want to increase revenues because the demand is most likely inelastic
2. Which of the following accurately characterizes a quasi-public good such as the Kansas Turnpike (which is a toll road):
a. It is rival in consumption and non-excludable
b. It is non-rival in consumption and non-excludable
c. It is non-rival in consumption and excludable
d. It is rival in consumption and excludable
3. The demand curve for your product is P = 220 – 2Q. Which of the following comes closest to the price elasticity of the demand for this product (in absolute value) as the price increases from $60 to $68?
4. What is the term, discussed in lecture, where the market- left to operate on its own –fails to produce the efficient or optimal level of output?
5. Which of the following is most likely correct?
a. The price elasticity of demand for a nonstop flight to NYC is larger (in absolute value) than the price elasticity of demand for a flight to NYC in general
b. The price elasticity of demand for a trip to Hawaii is larger (in absolute value) than the price elasticity of demand for toothpaste
c. The price elasticity of demand for gasoline is smaller (in absolute value) than the price elasticity of demand for pizza
d. Actually all of the above are most likely correct
Use this to answer the next three questions:
6. What is the elasticity of supply for this good?
7. Based on elasticity of demand, which is most likely correct about this good?
a. It is most likely a small part of consumer's budget
b. It is most likely a luxury
c. It is most likely a good that has few or no substitutes
d. Both a) and c) but not b)
8. Assume, as we did in lecture, that a $10 tax is placed on the seller of this good. What portion of that $10 tax will fall on the buyer of this good?
a. Approximately 33%
b. Approximately 67%
c. Approximately 54%
d. Approximately 24%
9. If two goods are complements and they are both normal goods what do we know?
a. Their cross price elasticity is negative and their income elasticities are both positive
b. Their cross price elasticity is negative and their income elasticities are both negative
c. Their cross price elasticity is positive and their income elasticities are both positive
d. Their cross price elasticity is positive and their income elasticities are both negative
10. Which of the following accurately characterizes a private good (such as a Starbuck's latte)?
a. It is rival in consumption and excludable
b. It is non-rival in consumption and non-excludable
c. It is non-rival in consumption and excludable
d. It is rival in consumption and non-excludable
Use this graph to answer the next 5 questions:
11. and 12. Assume you are at the intersection of curves A and B. the equilibrium quantity in this market is ________ and the equilibrium quantity is ___________.
13. Consumer surplus in this market comes closest to
14. and 15. Now assume it is discovered that this good exhibits a negative externality. "Incorporate" this externality as we did in sample questions and in class. After incorporating this externality the new quantity in the market will be
And the new consumer surplus in the market will be
16. You have already calculated the elasticity of demand for two products: Product X has a price elasticity of .74 (in absolute value)
Product Y has a price elasticity of 1.25 (in absolute value)
The current quantity demanded of Product X is 230 and the current price of Product X is $40
The current quantity demanded of Product Y is also 230 and the current price of Product Y is $30
Choose the product whose price you would decrease in order to increase revenues, and reduce that price by 10%. Which of the following comes closest to the new quantity that will be demanded of that product after the price decreases?
17. Which of the following comes closest to the new revenues you will earn from that product following the price decrease and corresponding change in quantity demanded?
18. Which of the following is correct based on the discussion of the Affordable Care Act (also known as "Obamacare") in the text and in lecture?
a. Under the Affordable Care Act an employer with 300 employees is required to offer health insurance to his employees
b. Under the Affordable Care Act an employer with 300 employees is required to either offer health insurance to his employees or pay a fee
c. Under the Affordable Care Act and employer with 18 employees is required to offer health insurance to his employees
d. Under the Affordable Care Act an employer with 18 employees is required to either offer health insurance to his employees or pay a fee
19. In our discussion and in the text, healthcare in the United States could best be described as _____while health care in Japan could best be described as______.
a. A third party payer system; a single payer system
b. A single payer system; universal health insurance
c. Socialized medicine; universal health insurance
d. None of the above
Use the following graph to answer the next questions about externalities.
20. Assume we have a product and this product exhibits a negative externality. Which of the following is correct?
a. Incorporating this negative externality takes the form of shifting Curve X to Curve Y
b. Incorporating this negative externality takes form of shifting from Curve B to Curve A
c. Incorporating this negative externality takes for of shifting from Curve Y to Curve X
d. Incorporating this negative externality takes for of shifting from Curve A to Curve B
4. market failure
11. quantity = 135
12. price = 340