Econ Midterm #1 10/5/15
Econ Midterm #1 10/5/15 Econ 1011
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This 8 page Study Guide was uploaded by Alex on Saturday October 3, 2015. The Study Guide belongs to Econ 1011 at George Washington University taught by Henry Terrell in Spring 2015. Since its upload, it has received 31 views. For similar materials see Principles of Economics: Microeconomics in Economcs at George Washington University.
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Date Created: 10/03/15
nter One First Principles Individual choice the choices individuals make Every economic issue involves individual choice decisions by an individual about what to do and what not to do The twelve economic principles 1 Choices are necessary because resources are scarce a Resources include land labor capital and human capital 2 The true cost of something is its opportunity cost a All costs are opportunity costs b Opportunity cost what you must give up in order to get an item you want 0 The opportunity cost of an item is its true cost 3 How much is a decision at the margin a Tradeoff a comparison of costs and benefits b These decisions require making tradeoffs at the margin comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less 0 Marginal decision whether to do a bit more or a bit less of an activity like what to do with your next dollar next hour etc 4 People usually respond to incentives exploiting opportunities to make themselves better off a The principle that people will exploit opportunities to make themselves better off is the basis of all predictions by economics about individual behavior 5 There are gains from trade a Trade people divide tasks among themselves and each person provides a good service that others want in return for different goods services that he she want b By dividing tasks and trading two people or countries can both get more of what they want than would be possible if they were both selfsufficient c The economy as a whole can produce more when everyone specializes in a task and trades with others 6 Markets move towards equilibrium a Equilibrium situation where individuals cannot make themselves better off by doing something different b Because people respond to incentives markets move towards equilibrium 7 Resources should be used efficiently to achieve society s goals a Economies are efficient when they take all opportunities to make some people better off without making others worse off 8 Markets usually lead to efficiency a Because people exploit gains from trade markets usually lead to efficiency b Market failure the individual pursuit of self interest found in markets makes society worse off 9 When markets don t achieve efficiency government intervention can improve society s welfare a Markets fail because individual actions have side effects that are not taken into account by the market one party prevents mutually beneficial trades form occurring andor some goods are unsuited for efficient management by markets 10 One person s spending is another person s income a If some groups decide to spend less the income of others will fall b Chain reactions in spending tends to have repercussions that spread through the economy 11 Overall spending sometimes gets out of line with the economy s productive capacity a Shortfalls in spending are usually responsible for recessions b In ation occurs from too much spending occurring in the market 12 Government policies can change spending a Government taxes spending and control of money are deployed in order to manage overall spending in the economy Chapter Two Economic Models TradeOffs and Trade Model any simplified representation of reality that is used to better understand reallife scenarios used to answer crucial questions about the market Models are either findingcreating a real but simplified economy or stimulating the workings of the economy on a computer Other things equal assumption all other relevant factors remain unchanged Production possibility frontier model that helps economists think about the tradeoffs every economy faces Points inside the production possibility frontier are feasible those outside are not Circular ow diagram schematic representation that helps to understand how the ow of money goods and services is channeled through the economy Efficiency an economy is efficient if there is no way to make some people better off without making others worse off Efficient in allocation the economy allocates its resources so consumers are as well off as possible When we assume the opportunity cost of an additional good doesn t change production possibility frontier is a straight line When opportunity costs are increasing the production possibility frontier is a bowed out shape Growth is shown as an outward shift of the production possibility frontier Growth occurs from an increase in the economy s factors of production or progress in technology Factors of production used by economists to refer to a resource that isn t used up in production Usually land labor physical capital or human capital Comparative advantage producing something if the opportunity cost of production is lower for one country than another Positive economics analysis that tries to answer questions about the way the world works which have definite right and wrong answers Occupies most of the time and effort of economists models play a crucial role Normative economics analysis that involves saying how the world should work This is about prescription rather than positive economics which is about description Powerful interest groups have an incentive to find and promote economists who profess their own opinions nter Three SuDDlv and Demm The concept of supply and demand is a model of how a market behaves Competitive market market in which there are many buyers and sellers of the same good Supply and demand model model of how a competitive market behaves Key elements Demand and supply curves Set of factors that cause the supplydemand curve to shift Market equilibrium including equilibrium price and equilibrium quantity How the market changes when the supplydemand curve shift The amount of any goodservice people want to buy depends on the price Demand schedule table showing how much of a goodservice consumers are want to buy at different prices Quantity demanded actual amount consumers are willing to buy at a specific price Demand curve graphical representation of the demand schedule Almost always slope downwards High price reduces quantity demanded low price increases quantity demanded Increase in demand is a rightward shift of the demand curve Decrease in demand is a leftward shift of the demand curve Principle factors that shift the demand curve Changes in the income tastes expectations number of consumers or prices of related goodsservices Substitutes pair of goods where a rise in price of one good makes consumers more likely to buy the other good Complements pair of goods where a rise in price of one good makes consumers less likely to buy the other good Normal goods demand for them increases when income increases Inferior goods demand for them decreases when income increases A fall income causes a rightward shift in the demand curve When tastes change in favor of a good more people buy it at any given price When tastes change against a good less people buy it at any given price Individual demand curve shows relationship between quantity demanded and price for an individual Market demand curve shows the combined quantity demanded by all consumers in the market Horizontal sum of the individual demand curves of all the consumers Quantity supplied quantity that producers of a goodservice are willing to produce and sell Supply schedule shows how much of a goodservice would be supplied at different prices Supply curve shows relationship between quantity supplied and price Higher price leads to a higher quantity supplied usually slope upwards Increase in supply is a rightward shift of the supply curve Decrease in supply is a leftward shift of the supply curve Principle factors that shift the supply curve Changes in input prices technology expectations number of producers and the prices of related goodsservices Input any goodservice used to produce another goodservice When input prices increase producers are less willing to supply the goodservice at any price and vice versa An increase in the anticipated future price of a good reduces supply now supply curve shifts left A decrease in the anticipated future price of a good increases supply now curve shifts right Individual supply curve shows relationship between quantity supplied and price for an individual Market supply curve shows how combined total quantity supplied of all individual sin the market depends on the market price Horizontal sum of the individual supply curves of all producers Equilibrium price price that matches the quantity supplied and the quantity demanded Equilibrium quantity quantity bought and sold at equilibrium price The price at which the two curves cross is the equilibrium price Surplus excess supply price of a good falls when there is surplus Shortage excess demand price of a good rises when there is shortage When demand for a good increases equilibrium price and quantity of the good both increase When demand for a good decreases equilibrium price and quantity of the good both decrease When supply for a good increases equilibrium price decreases and quantity increases When supply for a good decreases equilibrium price increases and quantity decreases When demand increases and supply decreases equilibrium price increases When demand decreases and supply increases equilibrium price decreases When both demand and supply increase equilibrium quantity increases When both demand and supply decrease equilibrium quantity decreases winter Four Consumer and Producer Surplus Consumer surplus benefits from being able to purchase a good Producer surplus benefits from being able to sell a good Willingness to pay max price at which a buyer will not purchase a good Individual consumer surplus net gain a buyer achieves from the purchase of a good Total consumer surplus sum of individual consumer surplus achieved in the market Area under the demand curve but above the market price When the price of a good falls total consumer surplus increases When the price of a good rises total consumer surplus decreases Cost lowest price at which a potential seller is willing to sell Individual producer surplus different between the price the seller actually gets and their cost Total producer surplus sum of the individual producer surpluses of sellers A fall in price decreases producer surplus a rise in price increases producer surplus Total surplus sum of consumer and producer surplus generated in the market Ways to attempt to increase total surplus Reallocating consumption by taking the good away from on consumer and giving it to another Reallocating sales by taking sales away form one seller and giving them to another To reduce transactions that would have occurred in the market To increase transactions by forcing producers who would not have sold at market equilibrium price to sell All of these decrease total surplus Efficient markets preform four basic functions Allocate consumption to buyers who most value it allocate sales to sellers who most value it ensure every consumer values the good more than the producer and ensure every consumer who doesn t purchase does not value the good more than the producer Three caveats Markets aren t always fair they sometimes fail and even when total surplus is maximized it doesn t always result in the best outcome for all consumers and producers Property rights valuable items in the economy have owners who can dispose of them Economic signal a piece of information that helps businesses make better economic decisions When markets don t achieve efficiency governments can improve society s welfare Inefficient there are missed opportunities in the market Three main reasons for market failure Monopolists prevent mutually beneficial trades from occurring actions of individuals have outcomes that are overlooked and sometimes goods are unsuited for efficient management by markets winter Five Price Controls and Quotas Meddling with Markets Buyers always want to pay less but sellers always want more money Price control when a government intervenes to regulate prices Price ceiling government interference in the form of an upper limit Price oor government interference in the form of a lower limit Price controls are usually imposed on efficient markets Price ceilings set a limit on the maximum amount that can be charged for a specific item Rent control in New York City only allows landlords to charge a maximum amount for rent Effects of rent control in NYC Reduces the quantity of apartments available Inefficient allocation of apartments Wasted time and effort as people search for apartments Landlords maintain apartments in low qualitycondition Deadweight loss lost surplus associated with the transactions that no longer take place due to market intervention Loss to society reduction in total surplus surplus that goes to no one as a gain In terms of New York City rent control those who badly need an apartment won t be able to find one those who don t need one as badly may be able to find one Inefficiently low quality sellers offer low quality goods at low prices even though buyers would rather have high quality goods at higher prices Landlords would be happy to maintain apartments with better conditions for a charge but this would be illegal as it would be above the price ceiling Three common results of price ceilings Shortage of the good inefficiency arising from shortage and black markets Most price ceilings hurt most people but benefit a small few Minimum wage governments maintain a lower limit on the hourly wage rate of a person s labor This is an example of a price oor Price oors lead to persistent surplus Price oors cause inefficiency in four ways Reduces the quantity transacted to below efficiency level inefficient allocation of sale waste of resources and sellers provide an inefficiently highquality level Price oors raise the price of a product and reduce the quantity demanded Reduces quantity of the product bought and sold at the regulated price leads to deadweight loss An inefficient allocation allocation of sales is when sellers who are willing to sell at the lowest price are unable to make sales and sales go to those willing to sell at a higher price Time effort and surplus are all wasted Inefficiently high quality sellers offer highquality goods at a high price even though buyers would rather a lower quality for a lower price Quantity control quota government regulates quantity of a good that can be boughtsold The New York medallion system in which a taxi cab driver must own a medallion in order to operate a taxi but there is only a set number of medallions available Quota limit total amount of a good that can be transacted under the quantity control Demand price price where consumers want to buy a given quantity As demand for a good rises the price of the good decreases Supply curve price at which suppliers will supply a given quantity In NYC medallion owners can either use their medallion to pick up customers or they can lease it out If they choose to lease it out they would get a percentage of the profits made Wedge when supply of a good s restricted this occurs between demand price of the quantity transacted and the supply price of the quantity transacted Quantity controls create deadweight loss and incentive to conduct illegal activities black markets nter Six El citv Price elasticity of demand ratio of percent change in quantity demanded to the change in price as we move along the demand curve Calculating the percent change in quantity demanded change in quantity demanded change in quantity demandedinitial quantity demanded 100 change in price change in priceinitial price 100 When the price of an ambulance ride increases form 200 to 210 the demand for rides decrease from 10 to 9 million yielding a change in the quantity demanded of 01 million rides change in quantity demanded 01 million rides 10 million rides100 1 Initial price is 200 and the change in price is 10 yielding percent change of change in price 10200100 5 Price elasticity of demand change in quantity demanded change in price Based on the ambulance example Price of elasticity of demand 15 02 Always a negative number When price of elasticity of demand is large demand is high elasticity To avoid calculating different elasticities for increasing and decreasing prices use the midpoint method change in X change in X average value of X 100 X is the average value of X Drop the minus sign and use the absolute value Perfect elasticity when the price elasticity of demand is infinite Elastic price elasticity of demand is greater than 1 Inelastic price elasticity of demand is less than 1 Unitelastic price elasticity of demand is equal to 1 Total revenue total value of sales of a product equal to the price multiplied by the quantity sold Total revenue price quantity sold Price effect when a price increases units sell at a higher price raising revenue Quantity effect when a price increases fewer units are sold lowering revenue The overall effect on revenue depends on which effect is the stronger of the two Unitelastic increase in price doesn t change total revenue Inelastic increase in price leads to a higher total revenue Elastic increase in price leads to a lower total revenue Which effect dominates depends on the price elasticity Unitelastic the two effect balance Inelastic the quantity effect is dominated by the price effect Elastic the price effect is dominated by the quantity effect When price is low demand is inelastic when price is high demand is elastic Four main factors determine elasticity If the good is a luxury good elasticity is high is the good is a necessity the elasticity is much lower If the good has no close substitutes elasticity is low if there are many substitutes elasticity is much higher If the good takes up a large portion of an individual s income elasticity is higher if not elasticity is lower Longrun price elasticity is usually higher than shortrun price elasticity Crossprice elasticity of demand ratio of the percent change in the quantity demanded of one good to another When two goods are substitutes this is positive if they are complements it is negative Elasticity is a unit free measure Income elasticity of demand measure of how much the demand for a good is affected by changes in the consumer s incomes Income elasticity of demand change in quantity demanded change in income Incomeelastic greater than 1 Incomeinelastic less than 1 Price elasticity of supply defined the same way as price elasticity of demand no minus sign Price elasticity of supply change in quantity supplied change in price Large when input is easily accessible small when it is difficult to obtain Shortrun elasticity a few weeks or months Longrun elasticity several years
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