ECON 200 Finals Study Guide
ECON 200 Finals Study Guide ECON 200
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This 9 page Study Guide was uploaded by Aaron Jin on Saturday June 6, 2015. The Study Guide belongs to ECON 200 at University of Washington taught by Melissa Knox in Spring 2015. Since its upload, it has received 353 views. For similar materials see Introduction to Microeconomies in Economcs at University of Washington.
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Date Created: 06/06/15
ECON 200 Final Study Guide Constructed by Aaron Jin Note Exams are graded on clarity and accuracy if it is not clear concise and legible you risk loss of credit State any and all assumptions up front Remember that only a simple calculator is allowed This study guide compiles information from class notes lectures homework assignments practice exams and the textbook The notes and the Panapto recordings are resources that are also available to you on the website as well as the practice exams I would highly recommend looking at some of the exams to get a sense of the type of questions you will likely be answering calculation graphing and explanationbased Utility and Consumer Decision Making Utility the satisfaction people get from the consumption of goods and services 0 Marginal utility amount of additional utility from consuming one extra unit I Remember Marginal additional from consuming one extra unit I Note that utility is measured in utils an unquantifiable unit made up by economists Law of diminishing utility consumers experience a diminishing amount of additional satisfaction as they consume more of a product during a given period of time Pizzas consumed on Super Bowl Sunday Slices Total Utility Marginal Utility 0 0 1 20 20 2 36 16 3 46 10 4 52 6 5 54 2 6 51 3 At 5 slices consumer will Tatal Utlhty Of Plzza experience max utility because that is the last point where marginal utility is positive Total Utility Quantity Marginal Utility of Pizza Marginal Utility Quantity Allocating Resources to Maximize Utility Determined using marginal utility per dollar spent calculated by dividing the marginal utility by the price which is the rate at which the consumer turns money into happiness 0 Below is a chart giving utility of pizza and coke pizza costs 2 coke costs 1 Total Mar inal M Utilit Total Mar inal M Utilit plzza Utility Uti ty S spean COke Utility Uti ty S spean O O O O 1 20 20 10 1 20 20 20 2 35 15 15 3 45 10 10 El 7 5 53 3 3 6 52 1 1 Rule of Equal Marginal Utility per Dollar Spent consumers will seek to maximize utility per dollar which is accomplished when the marginal utilitydollar spent is equal for both products 0 The reasoning is that the marginal utilitydollar spent is significantly lower for one product than the other then some of the money spent on that one product would have been better allocated if it was used to purchase the other product utility would not be maximized o If a consumer has 10 then she may purchase 4 pizzas and 2 cokes At 4 pizzas the MUS is 3 At 2 cokes the MUS is 15 Instead of purchasing a fourth pizza the consumer would have gotten more utility by purchasing two more cokes At 3 pizzas and 4 cokes the MUS for both are equal at 5 0 Also note that consumers will always exhaust their budget there is no utility in saving money I Consumers would not exhaust their budget past max total utility but this will likely not happen because consumers have scarce limited resources Price changes will affect the purchasing decision because the rule of equal marginal utility per dollar spent would not be satisfied How to adjust the purchase decision 0 Income effect consumer purchasing power changes according to price changes I Normal goods changes in income and changes in demand directly related This means that change in price and change in demand are indirectly related increase in price is like a decrease in income an increase in price will lead to a decrease in demand I Inferior goods changes in income and changes in demand indirectly related This means that change in price and change in demand are directly related an increase in price will lead to an increase in demand 0 Substitution effect product s price relative to other similar goods I 10 will give max utility at 3 pizzas and 4 cokes If the price of pizza drops to 150 then only 850 is needed to purchase 3 pizzas and 4 cokes The MU also changes and the MU of pizza will be greater than that of coke so more pizza will be bought to maximize utility I MU has the price in the denominator so an increase in price would result in a larger denominator and therefore a smaller MU To better understand this I included an example where the initial price is 1 then increased to 2 MU MU gt 1 2 Doubling the price results in half of the original MU Similarly a decrease in price would result in a larger MU 0 We ve mostly worked with demand curves that slope downwards but it is possible for a demand curve to slope upwards These are called Giffen goods I With an inferior good a price increase consumer demand more due to the income effect because purchasing power decreases and demand less due to substitution effect because the opportunity cost is higher I The demand curve can slope upwards only if it is an inferior good and the income effect is greater than the substitution effect and if the spending on the good is a large share of the consumer budget income effectgtsubstitution effect 0 Only known Giffen good is rice in china f rice prices increase people would continue to purchase the same amount of rice and then more because they would be unable to afford other foodsgoods Constructing Demand Curves Changing price will change the MU which can then be used to construct demand curves Start with preferences to construct individual demand curves then combine to construct the market demand curve sum of individual demand curves Price Individual Demand Market Demand 250 3 4 6 13 300 5 6 8 19 350 6 7 9 22 Social influences on demand In most standard economic models people are assumed to make choices independently of others ignoring the social aspects However we will examine some of these social aspects Celebrity endorsement consumer thinks quotthis celebrity knows more about this product than I do or quotI want to be more like this celebrity o Recognizes the fact that we are not perfect consumers with perfect information Network externality usefulness of a product increases with the number of consumers who use it Facebook blueray discs phone services etc 0 May result in market failure if people are locked into inferior products Fairness people like to act with quotfairnessquot and may do so even if it is bad financially o Ultimatum game and dictator game show that people tend to favor 5050 splits 0 When asked to perform tasks for money people become more willing to be unfair people value the perception of fairness Behavioral economics acts under the assumption that people are not always economically rational people don t walk around comparing MUS for every item they buy to the extent that economists do Just know that behavioral economics says that consumers do these things Ignore nonmonetary opportunities Super Bowl ticket situation Two questions o If paying in cash would you pay 3000 for a ticket o If win inexpensive ticket would you sell the ticket for 3000 0 Traditional economists say that if you answer quotnoquot to the first then you would say yes to the second HOWEVER this seems to not be the case as 94 said quotnoquot to the first but 92 still said no to the second I Endowment effect ownerships adds value Fail to ignore sunk cost rationally people would ignore sunk costs in making decisions because it cannot be recovered However people tend to think quotI already paid for part of it it would go to waste otherwise and end up losing more profit I Sunk cost cost already paid and cannot be recovered Be unrealistic about future behavior Often too optimistic about capabilities Technology Firms use inputs workers machines etc to produce outputs goods services etc This process is called technology 0 Note that technological changes may be positive or negative Short term period of time during which at least one of firm s inputs is fixed Long term no inputs are fixed anything can be changed in the long run all costs are variable Variable costs change as the output changes easily changed usually wages workers etc Fixed costs constant even if output changes not easily changed ovens machinery etc o On quantity vs cost graphs cost is not 0 even when quantity is 0 this is the fixed cost Explicit costs what the firm spends money on Implicit costs identifying resources that could have been used for other purposes foregone salary depression on assets etc Marginal product of labor additional output from hiring one more worker Average product of labor total output divided by number of workers 0 Note that this can also be calculated by taking the average of the marginal products of labor Law of diminishing returns at some point adding more variable input will cause the marginal product of variable input to decline Average total cost total cost divided by quantity of output Average fixed cost fixed cost divided by quantity of output Average variable cost variable cost divided by quantity of output 0 The average costs are colored corresponding to the total costs which are more lightly shaded The average costs are found by dividing the total costs by the number of pizzas 0 Note that fixed cost plus variable cost gives total cost Likewise average fixed cost plus average variable cost equals average total cost Marginal cost change in total cost from producing one more unit of output change in total cost divided by change in quantity Because the only part of the total cost that changes is usually the variable cost fixed costs don t change marginal cost can be found from AT C AVC wages AQ AQ MPL o The TC and pizzas values are highlighted so you know what points to use to calculate the MC Note that in this case the change in 39 may be used because the FC does not change 0f ovens pizzas FC VC T 0f ATC AFC AVC MC workers ovens workers PIzza 0 2 0 800 0 800 1 2 200 800 650 1450 400 325 325 2 2 450 800 1300 2100 467 178 289 260 3 2 550 800 1950 2750 500 145 354 650 4 2 600 800 2600 3400 567 133 433 1300 Graph of the AverageMarginal Costs ATC Cost Quantity pizzas Things to note about the graph 0 The MC curve cuts through both the ATC and the AVC curves at their minimum points 0 ATC is the sum of AVC and AFC although my model is a little off I Remember total cost is the sum of variable cost and fixed cost 0 The ATC and AVC will converge no distinction between the two in the long run Long Run In the long run all costs are variable and can be changed Smaller factories are able to produce smaller quantities at lover average costs than a larger one For larger quantities larger factories can produce it more efficiently 0 At low quantities firm may experience economies of scale where marginal costs are low as the output continues to increase I Lowest level of output where all economies of scale are exhausted is the minimum efficient scale 0 At some point firm experiences constant return to scale 0 Eventually firms may get so large they experience diseconomies of scale where marginal cost begins to increase as output increases 0 Long term average cost curve is constructed by connecting these previous curves Long term average COSt curve ATC Small ATC Large Firms experiencing diseconomies of scale Longrun Average Cost Curve Average Cost Quantity Market Structures and Profit Maximization Market structures are how firms interact with buyers to sell their output We are working mostly with perfectly competitive markets 0 Conditions many buyers and sellers all firms sell identical products and no barriers from entering the market 0 Because so many buyers and sellers of same product they are pricetakers unable to change the market price which is determined collectively Profit the difference between the revenue and the cost Rules for profit maximization for any firm 0 Producing at the level of output where profit is the greatest 0 Output where MRMC or the closest one as long as MRgtMC n perfectly competitive markets priceMR so profit maximization also when priceMC priceaverage revenuemarginal revenue Profit formula profitprice x quantity TC or profit price ATC x quantity Firm choosing quantity where MRMC to get profitmaximizinglossminimizing level of output Graph of the AverageMarginal Costs MC ATC MRDemandPrice PriceCost Profit Maximizing Quantity Quantity 0 Profit maximizing will ALWAYS be when MRMC Remember priceATC profit per unit of output 0 If p ATC then the company breaks even gains 0 for each unit sold 0 If p lt ATC then the company loses because loses money for each unit sold If firm experiencing a loss it may choose to continue producing or temporarily cease production still have to pay sunk costs such as building expenses and maintenance etc9l Shut down point of a firm is when MC AVC If not possible take the lowest possible AVC The firm will not produce if prices are below this value Perfect Competition in the Long Run Economic profits leads to entry of new firms other firms want to take advantage of the opportunity This increases the supply and the lowers the price until profit is 0 and there is no more incentive for other firms to enter lowers to the breakeven point Suppose firms breaking even until demand falls firms will lose money and some will exit the market lower the supply and increase the market price until it reaches the breakeven point Longrun competitive equilibrium situation where entryexit of firms in the long run will result in the typical firm breaking even 0 Increase in demand will increase the price and attract more suppliers which will in turn decrease the price back to the breakeven value 0 Decrease in demand will decrease the price and deter suppliers which will in turn increase the price back to breakeven value Productive efficiency good or service produced at lowest possible cost which perfectly markets are in the long run Allocative efficiency production accurately represents consumer preferences so every good produced so that last unit provides marginal benefit equal to marginal cost Perfectly markets are because pmarginal benefitmarginal cost Monopoly Market structure where firm is the only seller of a good without a close substitute There must be barriers to entry to prevent other firms from competing with it listed below 0 Government restrictions on entry patents copyrights trademarks etc or public franchise where government designates firm as only legal provider of good 0 Control over key resource if one firm owns all oil wells 0 Network externalities usefulness increases with number of users 0 Natural monopoly economies of scale are so large that one firm can compete with other firms combined often due to high fixed costs and not variable cost Monopoly s revenue up from additional sales but down due to lowered prices marginal revenue always lower than demand for a monopolist 0 Quantity is still determined by MCMR Subscribers Q Price P Total Revenue TR Average Revenue AR Marginal Revenue MR 0 60 O 1 57 57 57 57 2 54 108 54 51 3 51 153 51 45 4 48 192 48 39 5 45 225 45 33 6 42 252 42 27 Monopoly Revenue hAarghwalCost Average39TotalCost Den1andaverage Revenue PriceCost Profh NbrgmalRevenue Quantity The demand curve still determines the price and the average total cost determines average cost 0 No barriers to entry means no additional firms can enter market no distinction between short run and long run for a monopoly expect monopolists to continue to profit in long run f perfect competition became monopoly new firm maximized market profit with a lower quantity and higher price at the expense of consumer surplus and deadweight loss Although there are few monopolies many firms have market power ability to charge at a price greater than marginal cost Oligopoly small number of firms compete large and barriers to entry to prevent firms from competing away profits 0 Fourfirm concentration ratio if the four largest firms make larger than 40 of industry sales that it would be considered an oligopoly o Exist because barriers to entry usually economies of scale new firms have to smart smaller and have substantially higher average costs Game theory study of how people make decisions depending on interactions with other firms I Duopoly oligopoly with two firms I Dominant strategy the best strategy for the firm no matter what other firms do I Nash equilibrium each firm chooses best strategy based on what other chosen o If cooperate then could earn more but called collusion and is illegal in the US 0 Prisoner s dilemma try to get one to reveal the story enough try to get both to confess and push and go to jail for a long time but are they already in my jungle I Pricematch guarantee is an enforcement mechanism automatic decision to punish competing firm and price leadership following the lemming to price change I Cartel group of firms that agrees to restrict output to increase prices and profits 0 Sequential decision making one firm makes decision after other has been made Five Competitive Forces that determine overall level of competition 0 Existing firms Threat from new entrants Competition from substitutes Bargaining power of buyers Bargaining power of suppliers OOOO
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