Econ midterm study guide
Econ midterm study guide Econ 110
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This 4 page Study Guide was uploaded by Sydney Clark on Sunday October 9, 2016. The Study Guide belongs to Econ 110 at Brigham Young University taught by Kearl in Winter 2016. Since its upload, it has received 320 views.
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Date Created: 10/09/16
IMPORTANT CONCEPTS, PRINCIPLES AND ANALYTICAL APPROACHES opportunity cost o is the value of the next best choice that one gives up when making a decision o choice as the value of the best forgone opportunity incentive o Economic incentives are what motivates you to behave in a certain way, while preferences are your needs, wants and desires. *Side note* preferences are irrational o determined by cost associated with different choices o cost provides incentives gains from exchange o way of coordinating competing interests o invisible hand: everyone wins because of their own personal preferences o you are individually better off if you have the opportunity to exchange with someone else than you would be if you were alone o The gains from exchange are REAL, not imaginary o The gains from exchange exist because you and the other person have different values. o Exchange allows individuals to specialize gains from specialization o Specialization is when a nation or individual concentrates its productive efforts on producing a limited variety of goods. It oftentimes has to forgo producing other goods and relies on obtaining those other goods through trade. o Gains can be measured directly by considering the total output in 2 person economy o Determined by differences in relative production costs Differences in costs to individuals of producing one thing versus producing another o Specialization depends only on relative production costs, that is, on comparative advantage, not on overall productivity or absolute advantage. role of/reason for (i.e., what are the effects of transactions costs, opportunistic behavior, shirking, and “common property”) “prices” Selling price that includes direct, indirect, and hidden costs like downtime and opportunity cost. Firms Firms represent a division of labor and production costs. Small firms may retain one general manager, whereas larger firms have many levels of management and laborers. Organizing production by relying on teams allows individuals to specialize further property rights A private property system gives individuals the exclusive right to use their resources as they see fit. Allows individuals to own things rules governing contracting rules reduce uncertainty intermediaries/middlemen someone who specializes in trading lower transaction costs allow for more effective use of resources money Money is a medium of exchange in the sense that we all agree to accept it in making transactions. marginal analysis and maximization role of “marginal” unit addition satisfaction a customer gains from consuming one more good or service used to determine how much customer with purchase MB Maximum willingness to pay To maximize utility MC=MB MC the value of what is given up in order to produce that additional unit To maximize utility MC=MB Equal marginal rule an efficient level of product is achieved when marginal benefit is equal to marginal cost. Why? Maximizing irrelevancy of sunk cost rule A sunk cost is a cost that cannot be recovered or changed and is independent of any future costs a business may incur. Since decisionmaking only affects the future course of business, sunk costs should be irrelevant in the decision making process. what is a market o economy in which decisions regarding investment, production, and distribution are based on market determined supply and demand, and prices of goods and services are determined in a free price system. what is demand o describes a consumer's desire and willingness to pay a price for a specific good or service. a “picture” of substitution o a way of measuring willingness to pay for additional or marginal output (MWTP) o demand curve or, alternatively, marginal utility or marginal satisfaction the price suppliers can expect to receive for each unit sold o supply curve or, equivalently, average revenue what is supply (short run) o The firm's short‐run supply curve is the portion of its marginal cost curve that lies above its average variable cost curve. As the market price rises, the firm will supply more of its product, in accordance with the law of supply. a “picture” of diminishing returns o (when the amount of capital is fixed and the labor employed varies) a way of measuring marginal cost (MC) o Marginal cost is the increase or decrease in total production cost if output is increased by one more unit o The formula to obtain the marginal cost is change in costs/change in quantity. If the price you charge per unit is greater than the marginal cost of producing one more unit, then you should produce that unit. o or, alternatively, the cost of producing an additional or marginal unit the price necessary to induce suppliers to provide a given quantity to the market o equilibrium what is equilibrium o the price where the amount demanders are willing to purchase just equals the amount that suppliers are willing to provide to sell markets get to equilibrium because: When the demand and supply curves are combined, at the intersection of demand and supply, we can find the market equilibrium, which is the only price where the quantity demanded equals the quantity supplied. It's the exact price at which buyers are willing to buy a product or service and sellers are willing to sell it. o if the amount suppliers want to sell at a given price is greater than the amount that demanders wish to purchase at that price, then the market price will fall or 2) if the amount demanders want to purchase at a given price is greater than the amount that sellers wish to sell at that price, then the market price will rise o WHY? The equilibrium allows the supplier and demander to decide on a price and quantity that makes the MC=MB and maximizes their benefits o WHAT DOES EQUILIBRIUM MEAN? the price where the amount demanders are willing to purchase just equals the amount that suppliers are willing to provide to sell. Elasticity o the responsiveness of demand or supply to a change in price of the good or service (the “price” or “own price” or “demand” elasticity) income (the “income elasticity”) o income elasticity of demand measures the responsiveness of the quantity demanded for a good or service to a change in the income of the people demanding the good, ceteris paribus. It is calculated as the ratio of the percentage change in quantity demanded to the percentage change in income. o or 3) price of another commodity (the “cross price elasticity”) o in the case of “price” or “demand” elasticity, elasticity measures the degree of substitution that occurs as the market price changes o if substitution is “easy”, elasticity will be “high” o if substitution if “hard”, elasticity will be “low” put differently, when there are more substitutes, the elasticity of demand will be larger either more elastic or less inelastic o also in the case of “price” or “demand” elasticity, elasticity measures the effect of a price change on the total expenditures in a market (the total revenues for the firm or firms) o if demand is elastic, an increase in price will lower total expenditure and a decrease in price will increase total expenditure (demanders can find lots of substitutes if the price increases) o if demand is inelastic, an increase in price will increase total expenditures and a decrease in price will decrease total expenditures (demanders cannot find many substitutes if the price increases) estimating the own price elasticity of demand arc pointslope percentages relationship between direction of price change and change in TE (or TR) thinking about substitutes o supply elasticity what is equilibrium (long run) actual profits (TR TC) are determined by the relationship of average total cost (ATC) with average total revenue (p*): if p* > ATC, economic profits are greater than zero o (i.e., a firm is making more than a normal rate of return) if p*< ATC, economic profits are less than zero o (i.e., a firm is making less than a normal rate of return) if p* = ATC, economic profits are zero o (i.e., a firm is making a normal rate of return) if profits are greater than zero, firms will enter (or existing firms will expand) if profits are less than zero, firms will exit (or existing firms will downsize) o and therefore a market will be in long run equilibrium (i.e., there are no incentives for firms to enter or to leave the market) only when entering firms expect profits to be zero What is supply (long run) o firms can vary all of their input factors. o The ability to vary the amount of input factors in the long‐run allows for the possibility that new firms will enter the market and that some existing firms will exit the market. o entering firms may “look like” existing firms if so, longrun supply will be perfectly elastic (flat) at the minimum ATC (this is constant returns to scale or constant long run costs) o entering firms may have lower costs than existing firms if so, longrun supply will be downward sloping (this is increasing returns to scale or decreasing longrun costs) o “old” firms will have to come to look like “new” firms or exit o entering firms may have higher costs than existing firms if so, longrun supply will be upward sloping (this is decreasing returns to scale or increasing longrun costs) o “old” firms will earn “rents” what is efficiency (static or allocative) o Static efficiency is efficiency exists at a particular point in time. It is reached when consumers and producers make their decisions where the total net benefits from the use of a resource are maximized. o Allocative efficiency is a state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing. if firms are price takers (i.e., the market is perfectly competitive) AND if there are no consumption or production externalities then the market equilibrium is efficient because the amount demanders are willing to pay for additional output is just equal to the cost of producing additional output that is, “one dollar’s worth of scarce resources is used to produce output that individual’s are willing to pay exactly one dollar for” efficiency is achieved because: o maximizing demanders choose Q so that p* = MWTP o maximizing suppliers choose Q so that p* = MC and therefore MWTP = p* = MC and MWTP = MC what is efficiency (dynamic) o if firms are price takers (i.e., the market is perfectly competitive) o if there are no consumption or production externalities o AND there is “free”entry and exit (i.e., no barriers to either entry or exit) then the market equilibrium is dynamically efficient because capital will move to industries or activities where profits are greater than normal and be drawn away from industries or activities where profits are less than normal markets will adopt the most efficient technologies o markets will force out highcost firms (or force them to become like lowcost firms) o markets will minimize production costs (i.e., the market price will be equal to the minimum ATC o economic profits will equal zero; firms will earn a normal profit or rate of return what is the role of prices: o allocate commodities among competing demanders: provide incentives for suppliers to use capital more (or less) intensively provide incentives for demanders to substitute o convey information: among suppliers among demanders between suppliers and demanders o “shock absorbers” what is the role of profits: o allocate capital across different markets: provide incentives for capital to move to markets where economic profits are positive provide incentives for capital to move from markets where economic profits are negative APPLICATIONS o effects of change in income change in prices of other goods change in population change in wealth change in preferences or tastes change in prices of inputs change in available technology change in availability of imports (or change in world price) change in availability of exports (or change in world price) o SHORT RUN and LONG RUN The main difference between long run and short run costs is that there are no fixed factors in the long run; there are both fixed and variable factors in the short run . In the long run the general price level, contractual wages, and expectations adjust fully to the state of the economy.
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