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microeconomics exam 2 study guide

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by: Isabelle Hue

microeconomics exam 2 study guide ECON 1001

Marketplace > University of Cincinnati > Business > ECON 1001 > microeconomics exam 2 study guide
Isabelle Hue
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these notes cover the material for exam 2
Sourushe Zandvakili
Study Guide
Microeconomics, Economics, Study Guide, exam 2 notes
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"If you want to pass this class, use these notes. Period. I for sure will!"
Carroll Keebler MD

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This 13 page Study Guide was uploaded by Isabelle Hue on Saturday March 12, 2016. The Study Guide belongs to ECON 1001 at University of Cincinnati taught by Sourushe Zandvakili in Summer 2015. Since its upload, it has received 231 views. For similar materials see Microeconomics in Business at University of Cincinnati.


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Date Created: 03/12/16
CHAPTER 7 UTILITY MAXIMIZATION Law of diminishing marginal utility- The principle that as a consumer increases the consumption of a good or service, the marginal utility obtained from each additional unit of the good or service decreases.— simplest theory of consumer behavior rest on this law—consider a car, desire for one when you don’t have one is strong, but for a second is considerably less, and a third and fourth, weaker and weaker—unless they are collectors, event he wealthiest families rarely have more than a half dozen cars, even though they can afford them utility- The want-satisfying power of a good or service; the satisfaction or pleasure a consumer obtains from the consumption of a  good or service (or from the consumption of a collection of goods and services.—consumer derives utility from a  product if it can satisfy a want 3 characteristics of utility • utility is not synonymous with usefulness • utility is subjective • utility is difficult to quantify  total utility- The total amount of satisfaction derived from the consumption of a single  product or a combination of products. total utility derived from consuming some specific quantity-for ex 10 units-of a good or service- marginal utility- The extra utility/satisfaction a consumer obtains from the consumption of 1 additional unit of a good or service-for example the 11th unit; equal to the change in total utility divided by the change in the quantity consumed.—alternatively marginal utility is the change in total utility that results from he consumption of 1 more unit of a product—the change in total utility  graph of the relation ship between total and marginal utility  MARGINAL UTILITY & DEMAND ***the law of diminishing marginal utility explains why the demand curve for a given product slopes downward THEORY OF CONSUMER BEHAVIOR rational behavior-^^^ budget constraint- The limit that the size of a consumer's income (and the prices that must be paid for goods and services) imposes on the ability of that consumer to obtain goods and serv ices. utility-maximizing rule-oThe principle that to obtain the greatest total utility, a consumer should allocate money income so that the last dollar spent on each good or service yields the same marginal utility (MU). For two goods X and Y, with prices Px and Py, total utility will be maximized by purchasing the amounts of X and Y such that MUx/Px=MUy/Py for the last dollar spent on each good—when the consumer has balanced his margins using this rule he has achieved consumer equilibrium consumer equilibrium- In marginal utility theory, the combination of goods purchased that maximi zes total utility by applying the utility- maximizing rule. In indifference curve analysis, the combination of goods p urchased that maximizes total utility by enabling the consumer to reach the highest indifference curve, given the consumer's budget line (or budget constraint) UTILITY MAXIMAZATION OF THE DEMAND CURVE INCOME AND SUBSTITUTION EFFECTS **discuss how the utility maximization model helps highlight the income effects of a price change  income effect- A change in the quantity demanded of a product that results from the chan ge in real income (purchasing power) caused by a change in the product's price. increase in orange purchases after the price drops is called the income effect and it also explains the downward slope of the demand curve substitution effect-: (1) A change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in t he good's own price; (2) the reduction in the quantity demanded of the second of a pair of substitute resources that occurs when the price of the first resource falls and causes firms that employ both resources to switch to using more of the first resource (w hose price has fallen) and less of the second resource (whose price has re mained the same). also explains the downward slope of the demand curve “true value”=opportunity cost **individuals take actions to max utility  CHAPTER 8 BEHAVIORAL ECONOMICS neoclassical economics- The dominant and conventional branch of economic theory that attempts t o predict human behavior by building economic models based on simplifyi ng assumptions about people's motives and capabilities. These include th at people are fundamentally rational; motivated almost entirely by self- interest; good at math; and unaffected by heuristics, time inconsistency, and self-control problems behavioral economics- The branch of economic theory that combines insights from economics, p sychology, and biology to make more accurate predictions about human b ehavior than conventional neoclassical economics, which is hampered by its core assumptions that people are fundamentally rational and almost entirely self- interested. Behavioral economics can explain framing effects, anchoring, mental accounting, the endowment effect, status quo bias, time inconsistency, and loss aversion **the two two theories are complementary and work together to explain the behaviors of consumers—neoclassical explains that consumers buy more when prices are lower (respond strongly to incentives and prices) at the supermarket—while behavioral explains impulse buying (people buy what they see)—  rational- systematic errors- Suboptimal choices that (1) are not rational because they do not maximize a person's chances of achieving his or her  goals and (2) occur routinely, repeatedly, and predictably. heuristics- The brain's low- energy mental shortcuts for making decisions. They are “fast and frugal” a nd work well in most situations but in other situations result in systematic errors cognitive biases-: Misperceptions or misunderstandings that cause systematic errors. Most result either (1) from heuristics that are prone to systematic errors or (2) because the brain is attempting to solve a type of problem (such as a  calculus problem) for which it was not evolutionarily evolved and for which  it has little innate capability. • confirmation bias • hindsight bias • self serving bias • overconfidence bias • availability heuristic framing effects- In prospect theory, changes in people's decision making caused by new information that alters the context, or “frame of ref erence,” that they use to judge whether options are viewed as gains or los ses relative to the status quo. **hersheys bar changed size at a fixed 5 cent price status quo-The existing state of affairs; in prospect theory, the current situation from which gains and losses are calculated. loss aversion- In prospect theory, the property of most people's preferences that the pain g enerated by losses feels substantially more intense than the pleasure gene rated by gains. prospect theory- A behavioral economics theory of preferences having three main features: (1) people evaluate optio ns on the basis of whether they generate gains or losses relative to the status quo;(2) gains are subject to diminishing marginal utility, while losses are subject to diminishing margina l disutility; and (3) people are prone to loss aversion. anchoring- The tendency people have to unconsciously base, or “anchor,” the valuati on of an item they are currently thinking about on recently considered but l ogically irrelevant information. mental accounting- The tendency people have to create separate “mental boxes” (or “account s”) in which they deal with particular financial transactions in isolation rathe r than dealing with them as part of an overall decision- making process that would consider how to best allocate their limited bud gets across all possible options by using the utility-maximizing rule endowment effect-  The tendency people have to place higher valuations on items they posse ss (are endowed with) than on identical items that they do not possess; pe rhaps caused by loss aversion. status quo bias- The tendency most people have when making choices to select any option  that is presented as the default (status quo) option. Explainable by prospect theory and loss aversion.—explains brand loyalty and awesome organ donor example myopia-  Refers to the difficulty human beings have with conceptualizing the more  distant future. Leads to decisions that overly favor present and near- term options at the expense of more distant future possibilities. time inconsistency-  The human tendency to systematically misjudge at the present time what  will actually end up being desired at a future time. self-control problems- Refers to the difficulty people have in sticking with earlier plans and avoidi ng suboptimal decisions when finally confronted with a particular decision- making situation. A manifestation of time inconsistency and potentially avoidable by using precommitments. time inconsistency is the major cause of self control problems precommitments- Actions taken ahead of time that make it difficult for the future self to avoid  doing what the present self desires. See time inconsistency and self- control problems fairness- o A person's opinion as to whether a price, wage, or allocation is consider ed morally or ethically acceptable. dictator game- A mutually anonymous behavioral economics game in which one person (“th e dictator”) unilaterally determines how to split an amount of money with t he second player. ultimatum game- A behavioral economics game in which a mutually anonymous pair of players interact to determine  how an amount of money is to be split. The first player suggests a division.  The second player either accepts that proposal (in which case the split is  made accordingly) or rejects it (in which case neither player gets anything). CHAPTER 9 BUSINESSES AND THE COST OF PRODUCTION TERMS economic cost- A payment that must be made to obtain and retain the <i>services</ i> of a <i>resource;</i> the income a <i>firm</ i> must provide to a resource supplier to attract the resource away from a n alternative use; equal to the quantity of other products that cannot be pr oduced when resources are instead used to make a particular product.— • payment that must be made to obtain and retain the services of a resource- • it it is the income a firm must provide to resource suppliers to attract resources aways from alternative uses  • opportunity costs are incorporated in the calculation of economic costs • each resource used by a firm has an opportunity cost (for new resources as well as for resources already owned) (giving up the best alternative use for the resources already owned) • economic cost = explicit costs + implicit costs explicit cost-The monetary payment made by a <i>firm</ i> to an outsider to obtain a <i>resource</i>. includes • revealed costs • expressed costs implicit cost- The monetary income a <i>firm</ i> sacrifices when it uses a <i>resource</ i> it owns rather than supplying the resource in the market; equal to what t he resource could have earned in the best- paying alternative employment; includes a <i>normal profit</i>. • present but not obvious costs accounting profit-: The <i>total revenue</i> of a <i>firm</ i> less its <i>explicit costs;</ i> the profit (or net income) that appears on accounting statements and th at is reported to the government for tax purposes. • sales revenue — total explicit costs = accounting profit normal profit-The payment made by a <i>firm</ i> to obtain and retain <i>entrepreneurial ability</ i>; the minimum <i>income</ i> that entrepreneurial ability must receive to induce <i>entrepreneurs</ i> to provide their entrepreneurial ability to a firm; the level of <i>accountin g profit</i> at which a firm generates an <i>economic profit</ i> of zero after paying for entrepreneurial ability. • the typical or normal amount of accounting profit that you would most likely have earned in one of these other ventures  • labor-routine tasks-taking inventory, writing emails, sweeping the floor • entrepreneurial ability-any of the non routine tasks involved with organizing the business and directing its strategy-things like deciding whether to use internet ads or in person events to promote your business, whether to include childrens clothing in your product mix, and how to decorate your store to maximize its appeal to customers economic profit-  The return flowing to those who provide the economy with the <i>econom ic resource</i> of <i>entrepreneurial ability;</i> the <i>total revenue</ i> of a <i>firm</i> less its <i>economic costs</ i> (which include both <i>explicit costs</i> and <i>implicit costs</ i>); also called “pure profit” and “above-normal profit.” • revenue — economic costs (implicit & explicit) = economic profit • this formula allows you to compare your current venture with your best alternative business venture • if your economic profit is 24000$, that means you are making 24000$ more than you would in your best alternative, if —8000 means you are making 8000 less than you would in your alternative, and you’d want to switch • break even-when economic profit is 0 you are doing just as well as you would be doing in your alternative venture • economic profit directs how resources are allocated in the economy  • cost differ in the short and long term • may only take hours to alter labor, fuel, whereas it may take years ( in some cases) to alter plant capacity (the size of the factory, amount of machinery and equipment, and other capital resources) short run-fixed plant-1) In microeconomics, a period of time in which producers are able to change the quantities of so me but not all of the resources they employ; a period in which some resources (usually plant) are fixed and some are variable. (2) In macroeconomics, a period in which nominal wages and other input prices do not change in response to a change in the price level. • a period to brief to alter plant capacity  • long enough, however, to change the way the capacity is used—can vary its output by applying larger or smaller amounts of labor, materials, and other resources to that plant • fixed plant long run-variable plant-(1) In microeconomics, a period of time long enough to enable producers of a product to change t he quantities of all the resources they employ, so that all resources and co sts are variable and no resources or costs are fixed. (2) In macroeconomics, a period sufficiently long for nominal wages and other input prices to change in response to a change in a nation's price level. • period long enough for a firm to adjust the quantities of all the resources that it employs, including plant capacity  • variable plant total product (TP)-The total output of a particular good or service produced by a firm (or a group of firms or the entire economy). marginal product (MP)-  The additional output produced when 1 additional unit of a resource is em ployed (the quantity of all other resources employed remaining constant); e qual to the change in <i>total product</ i> divided by the change in the quantity of a resource employed. average product (AP)-  The total output produced per unit of a <i>resource</ i> employed (<i>total product</ i> divided by the quantity of that employed resource). law of diminishing returns- The principle that as successive increments of a variable <i>resource</ i> are added to a fixed resource, the <i>marginal product</ i> of the variable resource will eventually decrease. fixed cost-Any cost that in total does not change when the <i>firm</ i> changes its output. variable cost-A cost that increases when the <i>firm</ i> increases its output and decreases when the firm reduces its output. total cost-The sum of <i>fixed cost</i> and <i>variable cost</i>. average fixed cost (AFC)- A <i>firm</i>'s total <i>fixed cost</ i> divided by output (the quantity of product produced). average variable cost (AVC)-: A firm's total <i>variable cost</ i> divided by output (the quantity of product produced). average total cost (ATC)-: A firm's <i>total cost</ i> divided by output (the quantity of product produced); equal to <i>averag e fixed cost</i> plus <i>average variable cost</i>. marginal cost (MC)-: The extra (additional) cost of producing 1 more unit of output; equal  to the change in <i>total cost</ i> divided by the change in output (and, in the short run, to the change in t otal <i>variable cost</i> divided by the change in output). economics of scale-The situation when a firm's <i>average total cost</ i> of producing a product decreases in the <i>long run</ i> as the firm increases the size of its <i>plant</i> (and, hence, its output). diseconomics of scale-: The situation when a firm's <i>average total cost</ i> of producing a product increases in the <i>long run</ i> as the firm increases the size of its <i>plant</i> (and, hence, its output). constant returns of scale-  The situation when a firm's <i>average total cost</ i> of producing a product remains unchanged in the <i>long run</ i> as the firm varies the size of its <i>plant</i> (and, hence, its output). minimum efficient scale (MES)- The lowest level of output at which a <i>firm</i> can minimize long- run <i>average total cost</i>. natural monopoly- An <i>industry</i> in which <i>economies of scale</ i> are so great that a single <i>firm</ i> can produce the industry's product at a lower average total cost than w ould be possible if more than one firm produced the product. CHAPTER 10 PURE COMPETITION IN THE SHORT RUN market structure-The characteristics of an industry that define the likely behavior and performance of its firms. The primary characteristics are the number of firms in the industry, whethe r they are selling a differentiated product, the ease of entry, and how much control firms have  over output prices. The most commonly discussed market structures are pure competition, monopolistic competition, oligopoly, pure monopoly, and monopsony. pure competition-a market structure in which a very large number of firms  sells a standardized product, into which entry is very easy, in which the individual seller has no control o ver the product price, and in which there is no nonprice competition; a market characterize d by a very large number of buyers and sellers. pure monopoly-undefined monopolistic competition-a market structure in which many firms sell a differentiated product, entry is relatively easy, each firm has some control over its product price, and there is considerable nonprice competition oligopoly-a market structure in which a few firms sell either a standardized or differentiated product, into which entry is difficult, in which the firm has limited control over produ ct price because of mutual interdependence (except when there is collusion among firms), and in which there is typicall y nonprice competition imperfect competition- All market structures except pure competition; includes monopoly, monopolistic competition, and oligopoly. price taker -A seller (or buyer) that is unable to affect the price at which a product or resource sells by changing the amount it sells (or buys). average revenue- Total revenue from the sale of a product divided by the quantity of the pro duct sold (demanded); equal to the price at which the product is sold when all units of the product are sold at the sa me price. total revenue-The total number of dollars received by a firm (or firms) from the sale of a product; equal to the total expenditures for the  product produced by the firm (or firms); equal to the quantity sold (demand ed) multiplied by the price  at which it is sold. marginal revenue- The change in total revenue that results from the sale of 1 additional unit of a firm's product; equal to the change in total revenue divided by the change  in the quantity of the product sold. break-even point-An output at which a firm makes a normal profit (total revenue =total cost) but not an economic profit. MR=MC rule- The principle that a firm will maximize its profit (or minimize its losses) by producing the output at w hich marginal revenue and marginal cost are equal, provided product price is equal to or greater than average variable cost. short run supply curve-see slides/book CHAPTER 11 PURE COMPETITION IN THE LONG RUN long run supply curve-see book/slides constant-cost industry-An industry in which the entry and exit of firms have no effect on the prices firms in the industry must pay for resources and thus no effect on producti on costs. increasing cost industry-An industry in which expansion through the entry of new firms raises the prices firms in the industry must pay for resources and therefore increases their production costs. decreasing-cost industry-An industry in which expansion through the entry of firms lowers the prices that firms in the industry must pay for resources and therefore decreases t heir production costs. productive efficiency-The production of a good in the least costly way; occurs when production takes place at the output  at which average total cost is a minimum and marginal product per dollar's worth of input is the same for all inputs. allocative efficiency-  The apportionment of resources among firms and industries to obtain the production of the products most wanted by so ciety (consumers); the output of each product at which its marginal cost and price or marginal benefit are equal, and at which the sum of consumer surplus and producer surplus is maximized. consumer surplus-The difference between the maximum price a consumer is (or consumers are) willing to pay for an additional unit of a p roduct and its market price; the triangular area below the demand curve an d above the market price. producer surplus-The difference between the actual price a producer receives (or producers receive) and the minimum acceptable pr ice; the triangular area above the supply curve and below the market price. creative destruction- The hypothesis that the creation of new products and production methods  destroys the market power of existing monopolies.


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