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by: Lauren Vagnoni

Econ221 ECON 221 003

Lauren Vagnoni
GPA 4.0

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This is a study guide for Gordanier's second exam. The topics on this exam include elasticity, taxes, subsidies, externalities, and consumer theory
Principles of Microeconomics
John Gordanier
Study Guide
Economics, Microeconomics
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This 8 page Study Guide was uploaded by Lauren Vagnoni on Tuesday March 1, 2016. The Study Guide belongs to ECON 221 003 at University of South Carolina taught by John Gordanier in Spring 2016. Since its upload, it has received 47 views. For similar materials see Principles of Microeconomics in Economcs at University of South Carolina.


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Date Created: 03/01/16
Lauren Vagnoni Econ 122 Exam 2 Study Guide I. Elasticity a. Measures how responsive a dependent variable is to an independent variable b. Elasticity of demand is the measure of how responsive quantity demanded is to the price of the good. It is measured by taking the percentage change in the quantity demanded and dividing it by the percentage change in the price i. Example: If price rises 10% and quantity demanded falls by 5%, what is the elasticity of demand? ii. =% change dependent variable/% change independent variable iii. Elastic when greater than 1 iv. Inelastic when less than 1 c. Elasticity of supply is the measure of how responsive quantity supplied is to the price of the good. It is measured by taking the percentage change in the quantity supply ad dividing it by the percentage change in price d. Total Revenue: price x quantity i. When demand is inelastic and prices rise, revenues also rise e. Income Elasticity of Demand measures the responsiveness of quantity demanded to changes in income f. Cross-Price Elasticity of demand refers to the responsiveness of the quantity demanded of good X to changed in the price of good Y i. Calculated by the percentage change in quantity demanded of X divided by the percentage change in price of Y II. Taxes a. P cnd P PS;Pc= sax b. Tax-incidence refers to how much of the burden of the tax falls on consumers. It is calculated by taking the change in the total price paid by consumers due to the tax and dividing it by the tax. It is always a number between 0 (no burden on consumers) and 1 (the entire tax is passed on to consumers). i. PC PS = T ax ii. You can find the equilibrium by looking at each quantity and finding the quantity where the difference between the height of the demand curve and the height of the supply curve is equal to the size of the tax c. After a tax is imposed, the consumer surplus is the area between the price consumers pay and the demand curve d. Total surplus is the sum of CS, PS and TR i. Taxes have effects on the total surplus because the difference of the DWL. III. Subsidies a. Subsidy:one party to a transaction receives money from the government b. A subsidy is very similar to a tax. It can be thought of as a negative tax. The actual incidence will be determined by the elasticity of supply and elasticity of demand. c. When demand is perfectly inelastic it is difficult to see exactly where the wedge is going to be. If it is perfectly inelastic, the entire subsidy goes to the consumer d. Unlike a tax which raised revenue for the government, a subsidy is an expense that must be accounted for negatively e. The cost of the subsidy is the size of the subsidy times the number of units sold f. To evaluate the efficiency of the subsidy, you can measure the change in CS and the change in PS as a result of the subsidy IV. Externalities a. An externality is a cost or benefit to a non-market participant, that incurred as a result of a market transaction by someone who is not involved in the market transaction b. The marginal social benefit is the sum of the private costs of production, i.e. the supply curve, and the external costs (benefits) incurred by others (private benefit and external benefit) c. The marginal social cost is the sum of the private costs of production (private cost and external cost); example: the supply curve, and the external costs incurred by others MSB<Private benefit (demand) d. The efficient quantity is where the MSB=MSC; Thus there is deadweight loss as a result of the externality e. Efficiency Analysis i. Positive Consumption externality: external benefit>0. Graphically the MSB is above the private demand ii. Negative Consumption externality: MSB < private benefits. Graphically the MSB is below the demand curve iii. Positive Production Externality: MSC <the private costs. Graphically the MSC is below the supply curve iv. Negative Production Externality: MSC> the private costs. Graphically the MSC is above the supply curve f. A good is rival if one person’s consumption of the good prevents or detracts from another’s consumption of the good g. A good is excludable if it is possible to prevent one person from enjoying its benefits V. Consumer Theory a. Consumer choice: consumer choose the “bundle” that they like the best and that is affordable b. Bundle: a bundle refers to a combination of goods c. Indifferent curve: a graphical representation of preferences. All points (bundles) on an indifference curve a consumer is indifferent between i. Higher is better ii. Weakly bowed away from origin iii. Can’t cross d. Marginal Rate of Substitution (MRS): the amount of the good on the y-axis that a consumer would be willing to give up in order to get one unit of the x-axis and remain indifferent between the two. This is equal to the slope of the indifference curve e. Diminishing marginal utility: more and more of one good results in less satisfaction f. Budget Sets i. A budget set is like the individual version of the PPF g. Consumer Choice i. To describe consumer choice we want to find the highest indifference curve that is affordable ii. The optimal bundle is when the consumer’s indifference curve is tangent to the budget line iii. At point A, the indifference curve is just tangent to the budget line. That means that the magnitude of the slope of the indifference curve (MRS) is equal to the slope of the budget line h. Applications of Consumer Choice i. Substitution effect: buy more of what is getting relatively cheaper ii. Income effect: same slope, but changed place of the line to make tangent with the IC


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