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Microeconomics: Midterm 2 Study Guide

by: annehohler

Microeconomics: Midterm 2 Study Guide 2001.01

Marketplace > Ohio State University > Economcs > 2001.01 > Microeconomics Midterm 2 Study Guide
GPA 3.9
Dr. Ida Mirzaie

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Full of graphs, definitions, examples, and ways to remember different ideas. Enjoy, and good luck on the exam!
Dr. Ida Mirzaie
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This 21 page Study Guide was uploaded by annehohler on Saturday October 24, 2015. The Study Guide belongs to 2001.01 at Ohio State University taught by Dr. Ida Mirzaie in Summer 2015. Since its upload, it has received 354 views. For similar materials see Microeconomics in Economcs at Ohio State University.


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Date Created: 10/24/15
MICRO OH 7 l Chapter 7 Utility Utility a way of describing the value that a person places on something value of satisfaction people make decisions are made based on utility the desire to maximize utility drives decisions but it s not always rational emotions weigh more than rationality Thinking Strategically considering what other people are doing when making decisions gt Why not give people cash and let them decide what to do with it because in the broader view of utility cash is not the best gift remember emotions weigh heavy here SENTIMENTALITY comes from giving gifts other than money valuing objects more than money MONEY ISN T VALUE the OPPORTUNITIES we get in what we buy with the money is where the value comes from Hence utility comes from the experience Generally the things you like increase utility Utility Maximization doingdeciding what activities to do that will maximize utility or maximize satisfaction On a graph it s the data before the level of satisfaction becomes negative where llax Utility is O Rational Utility Maximizers people baseline assumption of how people think of the world it is not always true because people can lack information or lack in self control in decision making i am so sorry for my lack of self control MICRO OH 7 2 Utility is hard to measure because people are hard to measure When gauging other people s utilities we assume what they re doing is maximizing their utility Thus we buy them what maths their observed activities Basically we buy what we think they ll like based on what we know about them Problem is PEOPLE ARE NOT CONSISTENT They re always changing So is there more weight on what people say or what they do answer weighs more on what they do versus what they say Utility Function formula for calculating the total utility that a particular person derives from consuming a combination of goods andor services QUANTITATIVE Bundle unique combo of of goodsservices a person could choose to consume Marginal Utility a change in total utility that comes from consuming one additional unit or service MARGINAL ADDITIONAL Diminishing Marginal Utility principle that the additional utility gained from consuming successive units of a goodservice tends to lessen each additional item from the initial utility Enjoyment DECREASES with each additional goodservice MICRO CH 7 300 250 200 Total Joy 150 IVIU so 0 0 1 2 3 4 5 6 No of pizza slice So this is the curve that shows the maximum utility for this individual with and number Of Of pizza Their MU game is obviously weak but anyway P 175 1 5 1 25 1 0 75 And this is generally what s happening between enjoyment and marginal utility It s a negative or inverse relationship This also shows that their willingness to MICRO CH 7 4 pay for the item is decreasing as they keep consuming However the price of the item has not changed lt s iust their Willingness to keeping paying for the item at the set price is decreasing m m H t NUL 3 3 Affc rda ble 0 D U 2 I u 1 h Chosen Prolormd Lo I quot but 5 III affordalble f 10 0 10 Crumpets STEPS TO SOLVING BUDGET CONSTRAINTS TO FIND BEST WAY TO USE MONEY Have a budget Make a budget line Look at feasible bundles combos on the budget line Calculate total utility for each combination P gtP N Choose the bundle that maxs out total utility MICRO CH 7 5 Basically If this guy has 120 here are his options 1 Buy all tea no crumpets This means for 120 he can buy 30 cups of tea but no crumps Buy all crumps no tea This means for 120 he can buy 30 crumps but no tea BUT he can also buy cramps tea for 120 he can buy 15 cups of tea and 15 crumps woah now micro needs to chill If the Maximum Utility of item A divided by its price is larger than the Maximum utility of item B divided by its price then the quantity of A will increase change in consumption that results from increased effective wealth ie income increase due to lower prices Likein a hypothetical situation someone with the initial budget pays for a good that s 15 And that s that BUT when she gets an income increase of 5 though she s still paying 15 it feels to her like she s paying 10 because she s 5 richer An Increased lncome shifts the budget curve RIGHT and a Decreased lncome shifts the budget curve LEFT MICRO OH 7 6 change in consumption that results from change in relative price of goods the opportunity cost has changed therefore the person gets more utility for their buck Veblen goods when people choose to consume more of a good when it s price increases an exception to the rule basically items that have a status symbol are Veblen goods like Coach Chanel Rolex You know exactly what they are motive for action in which a person s utility increases simply because someone else s utility increases bragging rights desired one upping someone It s a selfish image conscious motive but sometimes it s unselfish and one wishes well for another responding to another s actions with a similar action matching someone tit for tat Doing good for someone who did good for you Or doing badly for someone who screwed you over Either are under this category Calculating Utility Functions Example If someone has the option of choosing to eat 3 units of item x 2 of unit y and 8 of unit 2 and she chooses l of unit x 2 of unit y and 2 of unit 2 then 3xl2x28x223 total offered of x times chosen amount of x plus total offered of y times chosen amount of y plus total offered of 2 times chosen amount of z total utility MICRO OH 7 7 Chapter ll Time and Uncertainty MONEY CHANGES IN VALUE CONSTANTLY 1 Million now is NOT the same as 1 Million in the future normally taking the money offered now is going to be the best choice mainly because people want money now rather than later especially when it s a gloriously large sum Future Value how much future value of is worth today Future Value of FVPV7 YAf39 Where r is the interest rate and t is the amount of time If the rate is not compounded annually and instead compounded semiannually quarterly monthly weekly or daily then r will be divided by the amount of times compounded per year and t will be multiplied by the amount of times compounded per year ie quarterly 4 times R4 and T times 4 Alternatively Present Value how much future cost is worth today Presemf Value of YAf39 Interest Rates 1 Price of money 2 Compensation for the opportunity 3 Costs of not consuming today MICRO OH 7 8 Problems with comparing future costs and future benefits with now i cannot directly compare costs and benefits of now vs the future We know the value of each NOW but the future is still unknown because MONEY IS CONSTANTLY CHANGING VALUE 2 to reiterate THE FUTURE IS UNCERTAIN BUT we can kind of gauge what the opportunity cost of now vs in the future can be to a degree Expected Value the average of each possible outcome of a future event weighted by its probability of occurring Expected Value gt evzm X 51 P2 X SZPm X Sm Risk Averse having a low willingness to take on situations with risk makes a market for insurance possible because these individuals will buy more expensive insurance to maintain security of unknown future misfortunes being taken care of Insurance provides them a peace of mind Risk Seeking the opposite of someone who is risk averse they have a high willingness to take on situations with risk and therefore buy less expensive insurance Premium a fee collected by companies for providing an insurance product paid in return for covering costs that clients would otherwise have to pay if they experienced misfortune Normally costs more than potential accident costs would actually be MIORO OH 7 Risk Pooling Organizing people into a group to collectively absorb the risk faced by each individual Foundational principle that makes insurance companies work CLIENTS PAY FOR OTHER CLIENTS Pooling DOES NOT decrease risk of a tragedy occurring it iust relocates the costs when they do happen so the total cost isn t entirely on the individual Risk Diversification process by which risks are shared across many different assets or people reducing the impact of any particular risk on any one individual INVESTING SMALL AMOUNTS IN MANY DIFFERENT COMPANIES NOT PUTTING ALL EGGS INTO ONE BASKET Adverse Selection a state that occurs when buyers and sellers have different information about the quality of a good or service or riskiness of a situation results in a failure to complete transactions that could ve been prevented if both sides had had the same information RISKS SHOULD BE AS UNRELATED AS POSSIBLE OR YOU RE SCREWED Moral Hazard tendency for people to behave in a riskier way or to renege on contracts when they don t face full consequences of their actions MIORO OH 7 l 0 Chapter 12 Costs of Production llain goals of a business I a bottom line because the profit made is on the bottom line of a profit statement it s not as exciting as it sounds 2 Maximize profits some companies also value social and environmental impact as a double bottom line or triple to achieve making these additional goals But normally these goals don t make a profit they just make the company look good so Proflszofal Revenue Tofal C051quot Total QQVQVIM Q7 X VT Q2 X PZquot39QM X W V Prfce Per omit solal Q of muffs solal Total Cosszofal FlXQOl Cost Total Variale Costs Fixed Costs indicate SHORT RUN costs that remain the same no matter how much of a product is produced ie land capital cannot change because of contracts fixed prices within a contract do not change during the duration of the contract Contracts also indicate how long a company doesn t have certain flexibilities Contracts can be one time or continual Variable Costs normally LONG RUN costs that depend on the level of production or costs of inputs ie labor and raw materials for production change with each additional unit produced calculated by finding Quantity times Variable Cost per unit LONG RUN is when every inputoutput cost is variable NO FIXED COSTS when variable costs equal 0 it indicates that productions have stopped MICRO OH 7 l l Implicit Costs composed of forgone opportunities opportunities that could ve been achieved if invested resources were invested elsewhere a sacrifice for a company Explicit Costs composed of fixed costs and variable costs require a firm to spend money ACCOUNTING COSTS spent money Accounting Profit profits for a company Accoumtfmg Profit Totat Qavemwa Ethfcft Costs Economic Profit potential losses for a company Economic Profit Totat Qavemwa Ethfcft Costs thtfcft Costs Accounting Profit is going to be more than Economic Profit because AP doesn t take into account implicit costs Investors are more interested in Economic Profit Production Function relationship between quantity of inputs and quantity of outputs Marginal Product Increase in output that is generated by an additional unit of input additional costchange in output slope of total production curve llarginal Product and llarginal Cost are ALWAYS inverse of each other on graphs Margfmat Product Change I39m Totat Product Chamge I39m 5 of workers MICRO OH 7 l2 Diminishing Marginal Product principle stating that the marginal product of an input decreases as the quantity of the input increases MP1 decreases as 0 increases creates U shape on graph Output Production Funcmon Total Production Curve captures just the total product can also read marginal product Peak before curve starts to flatten Labor Maximum average product Product MICRO OH 7 l3 Marginal Product DECREASES as Total Product INCREASES because of FIXED FACTORS Average Variable Cost total variable cost divided by quantity of output U SHAPED Average Fixed Cost total fixed cost divided by quantity of output DOWNWARD Average Total Cost total cost divided by quantity of output U SHAPED If a problem gives you a number of outputs produced an average total cost and an average variable cost OR fixed cost and asks you to find the total fixed cost OR variable cost here are the steps TC TFC TVC TCQ ATC TFCQ AFC TVCQ AVC Say you re asked to 74ml TFC If ATC 395 200 and AVC 395 750 f0 74ml AFC you fake ZOO 750 50zAFC If the Q is TOO Hiem reverse the AFC equation fake Q 100 TIMES AFC 50 5000 TFC MICRO OH 7 l 4 Here s an Average Costs Curve Marginal Cost relates to AFC ATC and AVC because it is an additional cost than can skew AVC therefore skewing ATC 1 MC ATC AVC Marginal Cost Cbamqa I39m Total Cost Cbamge I39M Quantity MICRO OH 7 i 5 AFC doesn t move with AVC and ATC because it is fixed This is easier to observe in a total cost graph A Cost TC TVC TFC Output gt Difference between Marginal and Average Average 395 CALCULATED Marginal 395 a SINGLE ADDITIONAL VALUE THAT CHANGES THE AVEQAGE Short Term Costs TFC TVC TC Long Term Costs GAUGED BY SCALES Economies of Scale returns that occur when an increase in the quantity of output decreases the average total cost ie discounts for buying in bulk vs singular purchase Diseconomies of Scale returns that occur when an increase in the quantity of output increases average total cost MICRO OH 7 l6 Constant Returns to Scale returns that occur when average total cost doesn t depend on quantity of output A FIRMS LONG TERM ATC CURVE COVERS MORE RANGE F OUTPUT THAN SHORT TERM ATC because there s more time for flexibility Short Term stuck on smaller cost curve limited capacity of fixed inputs Long Term lots of points various sizes and different scales can move around points basically a bunch of short runs strung to gether Companies always fluctuate between long term and short term Average Cost Diseconomies of Scale Economies of Scale Output Q Copyright 2003 lnvcdopcd39u com MICRO OH 7 l 7 Efficient Scale quantity of output at which average total cost in minimized when a firm cannot lower average cost by increasing or decreasing scale Returns to Scale relationship between quantity of output and average total cost lllllllllZES AC MICRO CH 7 i 8 its a lot of vocabulary so prepare yourself ie pollution caused by burning gas While driving Private Cost costs that fall directly on an economic decision maker directly on an individual Social Cost the ENTIRE cost of a decision including private costs and any external costs Private Benefit benefit that accrues directly to the decision maker Social Benefit entire benefits of a decision private and external the effect on the third party Positive Social Benefit Private Cost External Cost Negative Social Benefit Private Cost External Cost Negative Externality MTORO OH 7 l9 consumers buy less causing externality increase producers sell less causing quantity decrease the supply line shifts right Total SurPluS Commmer SurPqu Producer Surplus Exfermal Cosf Exfermal Beme f lmfermalfzeol Total Surplus Comwwar Surplus Producer Surplus Positive Externalities PUSHES externalities away from the efficient equilibrium level reducing total surplus Existence of positive externalities means that the market is NOT well functioning An efficient market DOES NOT equal a distribution of surplus Solving externalities is ALWAYS easier to describe than implement Coase Theorem by Ronald Coase a private solution to externalities even in the presence of an externality individuals can reach an efficient equilibrium thru private trades assuming zero transaction costs assumptions that must hold 1 people can make enforceable agreements contracts 2 NO TRANSACTION COSTS these conditions often don t hold true though MICRO OH 7 2 O Negative Externality gt Tax Pigovian Tax by Arthur Pigou tax meant to counter the effect of a negative externality results in revenue collected by the gov t includes sin taxes taxes on alcohol and cigs carbon taxes The surplus is higher under a tax than under a quota The tax has the ability to move the demand curve back to the optimal level ex negative externality shifts curve right but the tax can shift the curve back to the left Problems 1 setting tax to the right level is hard because the sensitivity to the tax is very subjective 2 there s no guarantee that the gov t canwill do anything to help the people who bear the external cost The revenue collected from the Pig tax is sometimes used as compensationbut sometimes not However it still maximizes total surplus in society as a whole Positive Externality gt Subsidy Tradable Allowance production or consumption quota that can be bought and sold as long as quota is set at the right quantity creates market in which quota rights are bought and sold among private parties MIORO OH 7 2i i Subsidies help consumer and producers capture the benefits of positive externalities 2 Distribution of the surplus depends on where the gov t gets the money to pay the subsidies 1 NOT ALWAYS FAIR but it maximizes total surplus as a whole 3 Sometimes less noticeable than taxes but very widespread and important 1 ie public schools subsidize cost of education Why not regulate quantity instead of taxing BECAUSE taxing allows freedom for the consumer to choose whether to buy or not and regulations of quantity take away that freedom meaning the market WOULD NOT BE EFFICIENT In a market with no externalities private costs and benefits are the same as social costs and benefits so there s a market equilibrium that maximizes total sur lus


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