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Econ 202 Study Guide 2

by: Leslie Pike

Econ 202 Study Guide 2 ECON 202

Marketplace > Western Kentucky University > Economcs > ECON 202 > Econ 202 Study Guide 2
Leslie Pike
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Chapters 4, 5, and 6; just about everything that could possibly be on our next exam should be on here. Methods of allocating resources, government control of markets, fairness and its definitions, ...
Dean Jordan
Study Guide
Economics, Econ 202
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This 4 page Study Guide was uploaded by Leslie Pike on Thursday March 24, 2016. The Study Guide belongs to ECON 202 at Western Kentucky University taught by Dean Jordan in Spring 2016. Since its upload, it has received 49 views. For similar materials see PRIN ECONOMICS-MICRO in Economcs at Western Kentucky University.


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Date Created: 03/24/16
Study Guide for Econ 202 Exam 2 Chapter 4: Elasticity Price elasticity of demand is the responsiveness of quantity demanded to a price change when all other factors remain the same. The elasticity can be computed as follows: %Change∈Quantitydemanded Elasticityof Demand= %Change∈Price %Change in quantity demanded is calculated by: Change∈quantitydemanded %Change∈Quantitydemanded= Averagequantitydemanded %Change in price is calculated by: Change∈price %Change∈price= Average price The resulting number is a unitless ratio. If the number is greater than 1, demand is elastic. If the number equals 1, demand is unit elastic. If the number is less than 1, demand is inelastic.  Inelastic: price has little effect on quantity demanded. Ex. Necessity items, such as food, insulin for a diabetic, drugs for an addict, etc. tend to be inelastic. You need them so badly you’ll buy them regardless of price.  Elastic: price has much effect on quantity demanded. Ex. Unnecessary items, or items where the market is full of competitors. Cell phones are elastic; Apple smartphones can be substituted for other smartphones, and customers want to buy the cheapest product. Raise your price, and the customers go to your competitor. Expensive vehicles are elastic; raise the price too much and people can’t afford them and will buy cheaper vehicles. Factors that influence elasticity:  Substitutes. If a good has substitutes (bottled water) the demand will be elastic, because people will want to purchase the cheapest substitute. If a good has no substitute, people won’t have other options to choose from when the price goes up.  Amount of income spent on good. Most people spend only a small portion of their income on gum, so gum makers sell about the same amount if their price if 50 cents or $1.50.  Necessities are inelastic. However, in impoverished countries, the demand will be more elastic because people have less income (note the above bullet point)  Luxuries are elastic.  If more time has elapsed since the price of a good was last changed, or a good can be stored for a long time without losing value, it is more elastic. Cross elasticity is the responsiveness to a price change of a substitute or complement. Income elasticity is percent change in quantity demand per percent change in income. Supply is elastic, just like demand. If resources have substitutes, supply is more elastic. If resources are fixed, supply is fixed. (Apple and Foxcon. Despite rising demand, Apple could only sell as much as Foxcon could supply.) Chapter 5: Allocation of Resources  Market: resources go to those who are willing to pay for them. Best way to run an economy  Command: someone in authority decided who gets what. Works well when positions and authorities are well defined, such as an employer telling an employee how to allocate his or her time. This does not work well for an economy.  Majority rule: the majority decides who gets what. This helps suppress self- interest because several people must agree on something.  Contest: works well when individual effort is hard to monitor. Does not work well for an economy (Hunger Games has a contest economy)  First come first serve: class registration, casual restaurant, Walmart checkout. This works well when resources can only serve one person at a time.  Sharing equally: self explanatory  Lottery: casinos, airport runways. Casinos generate millions of dollars of revenue. Lotteries work best when there is no effective way to allocate resources.  Personal characteristics (aka discrimination): works for choosing a soul mate, does not work for allocating resources  Force: the law is a prime example. The law keeps the government from taking all of your stuff, etc Value is what a consumer gets, price is what a consumer pays. A consumer won’t purchase if value is below price. This is called marginal benefit. If price is below value, you get a consumer surplus. Example: you are willing to pay $70 for a pair of shoes but they are on sale for $50, so you get a consumer surplus of $20. Cost is what a firm must give up to produce, price is what a firm receives. The marginal cost is the minimum price a firm will accept for its good or service. A supply curve shows the minimum price a firm will accept per unit of good or service for a particular amount of goods or services. A producer surplus is the excess amount received from the sale of a good or service over the cost of producing it. Market failure results when a market delivers an inefficient outcome. Market failures are generally caused by market regulation: taxes, subsidies, quotas. Market failures can also be caused by high transaction costs, such as sales taxes or tariffs. A public good benefits everyone. Examples of public goods are libraries, sidewalks, roads, national parks, public education, etc. A common resource is owned by no one but can be used by everyone. Example: fish in the ocean. Fairness is a normative idea. There are two definitions of fairness: 1. It’s not fair if the rules aren’t fair 2. It’s not fair if the outcome isn’t fair Utilitarianism is a Robin Hood-like idea; we take from the rich and give to the poor. An extra $10,000 would do a minimum-wage worker more good than it would a Bill Gates; therefore, we should take money from Bill Gates and give it to minimum- wage workers. This sounds great until you factor in what is called “The Big Trade-Off”. (Yes, everything involves a trade-off, what were you expecting?) Redistributing wealth is expensive. If we tax the rich to give to the poor, we need an IRS to ensure that taxes are being paid properly, and somebody has to pay the IRS. Every dollar taken from a rich person does not equal a dollar given to a poor person. When businesses are taxed in America, they tend to produce less, or take their business overseas, costing the U.S. millions of potential tax dollars. Utilitarianism just doesn’t work as well in the real world as it does on paper, because it makes the economic pie smaller. Even if the poor people are getting a bigger piece, it’s a bigger piece of a smaller pie. We would be better off trying to make the pie itself bigger, because when the pie grows everyone’s piece grows, including the poor person’s piece. Chapter 6: Government Regulation of Markets What happens when a government regulates the market? Let’s look at the labor market. Let’s say that minimum wage is raised to above the equilibrium point. More people will want to work, but fewer firms will hire them. This creates a surplus, known as unemployment. The higher-skilled workers (who likely were being paid considerably more than minimum wage in the first place) will keep their jobs, but the lower-skilled workers (who were paid minimum wage and whose salaries have been raised) are now too expensive for the company to afford, so they will be laid off, or the company will raise the prices of its goods and services to compensate, contributing to inflation. The now-unemployed people, who do not benefit a company enough to be paid the new, higher wage, will have to remain unemployed or be employed illegally and be paid in cash (chances are, they will make less than minimum wage). Minimum wage laws don’t really benefit the low-skilled workers that they are supposed to be helping. Examples of governments ruining markets are everywhere. The price cap on gasoline caused the gasoline shortage several decades ago, rent ceilings make housing scarce and cause apartments to be allocated by unfair means (discrimination, first come first served). The government is deliberately trying to ruin the tobacco market by imposing quotas on farmers, and taxes on buyers and sellers. It’s working, too—tobacco prices have gone through the roof and fewer people smoke now than ever before, despite the fact that nicotine is addictive.


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