Econ 201 Study Guide for Test #2
Econ 201 Study Guide for Test #2 ECON 2010
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This 0 page Study Guide was uploaded by Kathryn Catton on Tuesday March 22, 2016. The Study Guide belongs to ECON 2010 at a university taught by Dr. Zegeye in Winter 2016. Since its upload, it has received 62 views.
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Date Created: 03/22/16
ECON 201 Test 2 Study Guide Katie Catton A existence of buyers and sellers for a product a Perfectly Competitive Market large number of buyerssellers Each buyer is a price taker Entry and exit are free Products produced by all rms are identical or homogeneous b Pure Monopoly Single rm producing where there are not readily made substitutes gaswater company You can set your own price price maker c Monopolistic Competition a large number of buyers and sellers Each rm has its own brand name Price maker can t be dramatic though local restaurants Advertise more than price competing d Oligopoly fewer rms taking over the industry airlines auto shoes market in which there are many buyerssellers so both have an impact on market price a Perfectly Competitive above and Monopoly one seller that sets the price TV Cable company C Price of commodity and tastepreference are in question They have an inverse relationship Quantity demanded amount of good buyers are willing to or able to purchase The relationship of price and quantity demanded is so true and pervasive that economists call it the law of demand Cateris Paribus the claim that other things being equal the quantity demanded of a good fails when the price of the good increases and vice versa Many demand decisions use a demand schedule a table that shows the relationship between the price of the good and the quantity demanded It is accompanied by the demand curve a graph expressing the same relationship a the market demand at each price is the sum of the two individual demands It shows how the total quantity demanded of a good varies as the price of the good varies You add the two individual quantities on the horizontal line in order to nd the total quantity demanded Demand Curve will shift to the right when the demand for that product is favorable as an increase in demand It will shift left if the demand is unfavorable or there is none as a decrease in demand There are many variables that cause a shift i lncome if the demand for a good fails when income falls vise versa the good is called a normal good Not all goods are normal If the demand for a good rises when income falls the good is called inferior goods bus rides ii Price of alternative goods when a fall in the price of one good reduces the demand for another good the two goods are called substitutes or if the increase in the price of one leads to an increase in the demand for another Complements are goods that go together almost like pairs like ice cream and fudge P3 When a fall in the price of one good raises the demand for another good the two are complements Tastes what you favor or what you want to buy mostly based on psychological forces Demand quot Relationship P i39EE l5 399 Lia P1 Pa quot iv Expectations the future affects the demand for the goodservice it39 today Income increase in the future will make you save now and J spend more later 39 I I I D mg ndv Number of Buyers behavior of individual buyers within a group l l l impacts demand Earimmffj gg fwi Advertisements Informative or Persuasive vii Population the size of people increases or decreases quantity demanded c Prices of products won t change the demand for that product it changes the quantity demanded D Quantity supplied the amount of a good that sellers are willing and able to sell The relationship between price and quantity supplied is known as the Law of Supply the claim that other things being equal the quantity supplied of a good rises when the price of the good rises The supply schedule is the table that shows the relationship between the price of a good and quantity supplied The supply curve is in relation being a graph of the relationship between the price of a good and the quantity supplied Market Supply vs Individual Supply is the same as demand above a i Input Priceswhen the price of one or more inputs rises producing the good is less pro table and rms supply less Technology by reducing rm s costs advances in technology and reducing the amount of labor to make the product will be more ef cient in supply Supply Relationship Empty H 39 iii Expectations If rms decide to rise prices later it will put 1 current production into storage and supply less to the market quot I today 5 E quot iv Number of Sellers Least amount of sellers retirement means the market supply will fall U A v Price change of substitute products in production or another unit tax on producer weather and the cost of production a the point at which the supply and demand curves intersect The price at which they intersect is called the equilibrium price market clearing price the quantity of the good that buyers are Willing and able to buy EXACTLY balances the quantity that sellers are Willing and able to sell The quantity is called the equilibrium quantity All sellers and buyers are satis ed there is no upward or downward pressure on the price i There is a surplus of a good when the quantity supplied is greater than the quantity demanded Supply exceeds demand Here suppliers are unable to sell all they want at the going price F So they cut their prices to lower their excess supply These changes represent movements along the curves ii There is a shortage when the quantity demanded is greater than quantity supplied Demanders are unable to buy all they want at the going price Also known as excess demand it depends on the position on the curves IWe decide if it shifts either of the curves ii We decide whether the curve shifts left or right LWe use the supplyanddemand diagram to compare the initial and new equilibrium 1 Shifts in Curves vs Movements along the Curves Suppy refers to the position of the supply curve whereas the quantity supplied refers to the amount of suppliers wish to sell When the price rises the quantity supplied rises quotChange in demandsupplyquot are SHIFTS in the curves quotChange in quantity demandedsuppliedquot are MOVEMENTS along curve If the price decreases later sell less now and more in the future If the price increases later sell more now and less in the future When Quantity Supplied Quantity Demanded there is an equilibrium The price at which the equilibrium point stands is called the price equilibrium or the market clearing price The quantity at which the equilibrium point stands is called the quantity equilibrium This means that consumers are buying all the products they want and suppliers are selling all they want V flu Price Ell Equilibrium 39 Ar L yl emalnd I Il 39ll 1 Que nltity apyrig l am a Irmnslnpnudiraxnm The points above the equilibrium pricequantity when Quantitv Suoplied exceeds or is greater than Quantity demanded it is called disequilibrium or usually an excess supply surplus In this case the price should decrease to be more ef cient The points below the equilibrium pricequantity when Quantity Supplied is less than the Quantitv demanded it is called disequilibrium or usually an excess deman hlshor 39 e In this casemme price should increase to be more ef cient Pl l5 3 El l l New Equilibrium F l 39 7 i quot 39 Price D m rhl quot i ElEl M 12 Qua ntiw J What happens to the equilibrium price and quantity if a Demand changes while supply remains constant demand shifts left or right b Supply changes while demand remains constant supply shifts left or right c If both demand AND supply change simultaneously i Both demand and supply increase ii Both demand and supply decrease iii Demand increases while supply decreases iv Demand decreases while supply increases Elasticity a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants Elastic the demand is elastic if the quantity demanded responds substantially to changes in the price lnelastic demand is inelastic if the quantity demanded responds only slightly to changes in price the responsiveness of quantity demanded due to some change in the price of the goodcommodity in question A measure of how much the quantity demanded of a good responds to a change in the price of that ood I I ia i qua tity ed E Change In Quantity Change In PrIcE 2 ya 1 1 r m pine Own Price Elasticity P E Change in 00 times PChange in P Q2 Ql as you move down the curve from Q2 Q point A to B Switch Ql and QZ along IE I 2 AQ with P1 and P2 to nd E moving from d P2 Pl AP point B to A Moving up the curve you P2 131 SWitCh 2 The Absolute Value removes the negative Sign What determines the size or magnitude of price elasticity of demand 1 Availability of substitutes highly elastic 2 A necessity or luxury item 3 Length of time that elapses after the price change before the quantity demanded is measured 4 Long and short run elasticities 5 The percentage of your income devoted to the good Small quotthe importance of being unimportantquot 6 De nition of the market narrowly or broadly de ned 392 Q You do the same thIng from E 39 above movmg from pomt A to B 39D 55 quotPi and Bto A They may end up 5 9 being the same answer for both parts Absolute value of E gt 1 demand is price easti ADChange of Q gt Change of P Highly substituted products like coffee and tea or beef and pork They are like most luxury items Absolute value of E lt 1 demand is price inelastic Change of Q lt Change of P Unresponsive water price most necessities Absolute value of E 1 demand is of unit elasticity Change of Q Change of P Absolute value of E O demand is perfectly inelastic Change of Q 0 Change of P Medications Absolute value of E in nity demand is perfectly eastic Change of Q Change of P 0 Price Perfectly inelastic 1 Relationships between price total revenueexpenses and Elasticity P Q total expenditures TR by producer Perfectly P elastic k Llnit Elasticity l U ElutirltitI kiwiright wwwtecannmmr whimstriple Price Quantity Total Revenue by producers the amount paid by buyers and received by sellers of a good computed as the price of the good times the quantity sold Price Quantity Total Revenue E 10 1 10 9 2 18 633 8 3 24 340 E gt 1 7 4 28 214 6 5 30 144 5 6 3O 1 E 1 4 7 28 069 3 8 24 047 mean HI 2 9 18 029 E lt 1 E gt 1 Price Decreases Total Revenue Increases 1 E gt 1 Price Increases Total Revenue Decreases Demand Demand is PRICE ELASTIC P and TR go in opposite directionsammnu MR Q an iy E lt 1 Price Decreases Total Revenue Decreases n E lt 1 Price Increases Total Revenue Increases MAX Demand is PRICE INELASTIC P and TR go in same direction Either way when E 1 TR will remain constant Quantit almost the same as Price elasticity but you use Income instead of Price A measure of how much the quantity demanded of a good responds to a change in consumers income computed as the percentage change in quantity demanded divided by the percentage change in income Income Elasticity 739 l Ql AQ E 12 2 II 7AI I IE l gt 0 Normal a 0 lt1 E lt1 1 Necessity 39 IEquot gt 1 Luxury Em lt10 Inferior Income elasticity can be either negative or positive If elasticity of income is positive and greater than 1 it is a luxury good If income is positive and less than 1 it is a necessty measure of how much the quantity demanded of one good responds to a change in the price of another good computed as the percentage change in quantity demanded of the rst good divided by the percentage change in the price of the second good Whether the crossprice elasticity is a positive or negative number depends on whether the two goods are substitutes or complements The schedule can include either complements or substitutes E of AB represents the equation in comparison of schedulegood A or B An example would be coffee A and tea B They are substitutes The equation would look like this CTGSS Pl ice Elaglngll oz Q1Q2Q1 of A P2P1P2P1 of B Toni F 2 J 4in 39 E PM Pkg P3 2 391 Em 2 0 Substitutes ll tilr l l 39 EW 2 Cl Complements ljl39 or 4 39 Em If Unrelated goods DEE r Ella a measure of how much the quantity supplied of a good responds to a change in the price of that good computed as the percentage change in quantity supplied divided by the percentage change in price The price of elasticity of supply depends on the exibility of sellers to change the amount of the good they produce Examples of elastic manufactured goods cars books and TV s Inelastic beachfront land The equation is the exact same aEfastiit tly lahslulpptyyou include supply and base it off of the supply schedule P Qg Ql 02 Ql E 2 r P P AP xiii m ill lty audited P1 39 ein rice gt i Elastic 2 E5 is l inelastic E3 l Unitary elastic Absolute value of E gt 1 supply is price elastic Change of Q gt Change of P Excess capacity too many buildings or machines not being used Absolute value of E lt 1 supply is price inelastic Change of Q lt Change of P Absolute value of E 1 supply is of unit elasticity Change of Q Change of P Absolute value of E 0 supply is perfectly inelastic Change of Q 0 Change of P Parking spaces and seats in the classroom Absolute value of E in nity supply is perfectly inelastic Change of Q Change of P O p Perfectquot I inelastic Perfectly P39 E 315th k U l l ti EIa tlli ty l uai39ltlty ft ip39ylilght 39ia lllll 39a39a39a39 3 39l llll39ml39lll39l39l 39JJJk Because buyers of any good always want a lower price while sellers want a higher price the interests of the two groups con ict The government can impose a legal maximum on the price for the products to be sold Because the price is not allowed to rise above this level the legislated maximum is called a price ceiling In contrast the government can impose a legal minimum on the price Because the price cannot fall below this level the legislated minimum is called a price oor If the price ceiling is below equilibrium it is NOT BINDING Market forces naturally move the economy to the equilibrium and the price ceiling has no effect on the price or quantity sold If the price ceiling is above equilibrium it is a BINDING CONSTRAINT Once it hits the ceiling it can t by law rise any further If equilibrium is at 3 an ice cream cone it would be NOT BINDING at 4 price ceiling and BINDING at 2 price ceiling At this point if Quantity demanded exceeds Quantity Supplied there is a shortage When the government imposes a binding price ceiling on a competitive market a shortage of the good arises and sellers must ration the scarce goods among the large number of potential buyers Effect of Price Ceiling P F S r 5 Price Ceiling p A D A Ceflllllll gi 39 if Hungrybinding price Binding price cenlmg ceiling like ceilings price oors are an attempt by the government to maintain prices at other than equilibrium levels Unlike ceilings a price oor places a legal minimum price If the equilibrium is above the price oor the oor is NOT BINDING If the equilibrium is below the oor the price oor is a BINDING CONSTRAINT Once it hits the oor it can t go lower A binding price oor causes a surplus Effect of Price Floor F p S 39Surplus I S V y ne ofquot Teanr rienciples of Economics states why econo is s ugsuall o pposepprice ceilingsgannld oors Prices to them are the result In busirgwess and consumer decisionsDthat lie behind the supply and demandEccl 39rves ePriceSQDalarJrcem1q demand coordinating economic activityn 395ic3pcontrols are als g a39llypa39 med at the poor such as the rent control laws and the minimum wage laws important tool used to raise revenue for public projects like roads schools and national defense A tax incidence shows how a tax is divided to take the burden on either the suppliers or buyers Suppose the local government passes a law requiring sellers of ice cream cones to send 50 to the government for each cone they sell How are buyers and sellers affected 1 Decide whether the law affects the supply curve or demand curve 2 Decide which way the curve shifts 3 Examine how the shift affects the equilibrium price and quantity Demand remains the same however the supply curve shifts because the tax is on the sellers and it makes the ice cream business less pro table at any price The tax reduces the quantity supplied at every price supply curve shifts to the left It moves upward as well because of the 50 tax slightly Price must be 50 higher 3L Price increases and quantity supplied decreases Tax reduces the size of the ice cream market Who pays the tax Tax incidence Both buyers and sellers share the burden the market price rises and buyers pay 30 more for each cone Sellers get a higher price from buyers than before but what they get to keep after paying the tax is 280 compared to the 3 before tax Now a tax is levied on buyers of a good They have to send 50 to the government for each cone they buy Supply is not affected but the demand curve is affected Buying ice cream is less attractive with a tax demand curve shifts to the left It shifts downward as well because of the 50 tax 3L Price decreases for the sellers from 300 to 280 but rise for the buyers to 330 50 The quantity demanded of cones decreases as well Both the buyers and sellers share the burden The tax burden is rarely shared equally how do we gure it out The relative elasticity of supply and demand When supply is elastic sellers are very responsive to changes in price whereas buyers aren t very responsive When the tax is imposed the price received by sellers doesn t fall much so they carry a small burden However the price paid by buyers rises substantially the buyers end up bearing the most burden of the tax The more elastic supply or demand is the lesser amount of burden you have The elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable A small elasticity of demand means that buyers do not have good alternative to consuming this particular good A small elasticity of supply means that sellers do not have good alternatives to producing this good When the good is taxed the side of the market with fewer good alternatives is less willing to leave the market and has the bigger burden Welfare Economics the study of how the allocation of resources affects economic wellbeing To start we examine the bene ts that buyers and sellers receive from engaging in market transactions In any market the equilibrium of supply and demand maximizes the total bene ts received by all buyers and sellers combined the maximum amount that a buyer will pay for a good Consumer Surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it It measures the bene t buyers receive from participating in a market The area below the demand curve and above the price 1 measures the consumer surplus in a market Total expend39 Consumer Surplus Total Bene t PE the less that L i spend compared to what you are willing to spend w raise consumer surplus ill alaways ua mtiiy 1F 1 2 3 III 4 5 6 T To make judgements about the desirability of market outcomes It is a good measure of economic wellbeing if policy makers want to respect the preferences of buyers Rational decisions represent consumer surplus the best Cost the value of everything a seller must give up to produce a good Producer Surplus is the amount a seller is paid minus the cost of production It measures the bene t sellers receive from participating in a market The area below the price and above the supply curve measures the producer surplus in a market The height of the supply curve measures seller s costs and the difference between the price and the cost of production is each seller s producer surplus thus the total area is the sum of the producer surplus of all sellers the more the producers se compared to the cost of production the higher the producer s Total Surplus Consumer Surplus Producer Surplus Marginal Cost gt Marginal Bene t which is inef cien Right side of the graph of total surplus I To conclude that markets are ef cient we about how the market worked a Perfectly competitive market b No externalities FIAIIII IIJIUD PI PI P39ripa P t on the P uamtiw 1F made several assu39mptions39 ll When these assumptions do not hold the market equilibrium may not be ef cient lll When markets fail public policy can potentially remedy the situation When a tax is levied on sellers the supply curve shifts upward by the size of the tax when it is levied on buyers the demand curve shifts downward by that amount In the end the elasticities of supply and demand determine how the tax burden is distributed between producers and consumers A tax on a good places a wedge between the price that buyers pay and the price that sellers receive The quantity of t39htesgood sold falls In total a tax on a good causes the size of the market for the g jggl to hrink L Supply a 1M Wil il lml ex 4 I m Demand Quantity ll exeise ten re uees hem um g and Pm mteers39 sueplueee Consumer and producer surplus for the buyers and sellers However there is a third party the government The government earns the tax revenue of the size of the tax times the quantity of the good sold TQtax revenue These revenues can be spent on public services like roads police public education or helping the needy It is represented on the graph as the area of the rectangle between the supply and demand curves Welfare with NO Tax It is at normal equilibrium the consumer surplus is ABOVE equilibrium price P and producer surplus is BELOW the price Total Surplus is both producer and consumer Welfare WITH Tax With a tax the price rises So from the new higher price consumer surplus is the upmost areabelow the demand curve but above buyer s price Producer surplus is the lower most areaabove the supply curve and below the seller s price Changes in Welfare The tax makes buyers and sellers worse off and the government better off The change includes the change in consumer surplus negative the change in producer surplus positive and the change in tax revenue Thus the losses to buyers and sellers from a tax exceed the revenue raised by the government The fall in total surplus that results from a market distortion such as a tax is known as a deadweight loss Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade The price elasticities of supply and demand When supply or demand is relatively inelastic the deadweight loss of a tax is small When it is elastic the deadweight loss is larger As the size of a taX raises the deadweight loss grows larger and larger Deadweight loss of a tax rises more rapidly than the size of the tax The higher the tax tax revenue fails because the higher the tax reduces the size of the market SMALL TAX MEDIUM TAX LARGE TAX Q1 00 Q Q1 00 Q Laffer Curve As the size of a tax increases its deadweight loss quickly gets larger Tax revenue rst rises with the size of the tax but as the tax increases further the market shrinks so much that the tax revenue starts to fall However deadweight loss continuously increases below The Le er EUWE Tm Revenue Deadweight Leee Ten Hate res Ta tnp39 uril l 39a39ini39l Imael lnpediamznm 7
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