exam 1 ECON 2306 - 009
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This 24 page Study Guide was uploaded by shal on Friday October 30, 2015. The Study Guide belongs to ECON 2306 - 009 at University of Texas at Arlington taught by Todd Russell Gabel in Summer 2015. Since its upload, it has received 91 views. For similar materials see Introduction to Microeconomics in Economcs at University of Texas at Arlington.
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Date Created: 10/30/15
ECON 2306 091515 Midterm 2 578 Technical issues with demand Chap 51 52 changes in demand verses changes in quantity 1 How will a change in the price of another good change demand when Py increases demand for good X increases Demand quotshifts to the rightquot Substitutes Suppose two goods X and Y r substitutes When pY Ex when the price of coke goes up demand for pepsi increases graph Why a change in demand Relationship btw price and quantity fundamentally changed Graph By contrast change in quantity demanded Same relationship btw price and quantity just a movement along the demand curve Graph Complements Suppose two goods X and Y r complements When Py increases demand for good X will decrease Demand quotshift to the leftquot Ex when prices ofjam goes up demand for peanut butter decreases graph 092215 2 How will a change in income change demand Itdepends Normal goods Suppose the good is a normal good When income rises demand for the good increases Demand quotshifts to the rightquot Inferior Goods Suppose the good is an inferior good When income rises demand for the good decreases Demand quotshifts to the leftquot 3 How will a change in preferences change demand Itdepends Effect of preferences During the holidays we would expect our demand for gasoline to increase Demand shifts to the right True or False 1 quotAll goods cannot always be inferior at the same timequot True 2 quotWhen the prices increases demand goes downquot False 3 quotGoods must be either complements or substitutesquot False Some goods are both substitutes and complements Hotdogs and hamburgers Fuelef cient cars and gasoline Video game consoles and HD televisions Elasticity of Demand Address the fundamental question How responsive are consumers to changes in price How easily do they substitute away from goods The jacket 1 Responsive ness Responsive Elastic Non Responsive Inelastic Point Elasticity How to determine sensitivity to price changes at a particular point on a demand curve EX Elasticity of Demand quotOwn Price Elasticityquot Graphically How responsive is Tommy Percent increase in ticket price is 100 they ve doubled 200100 100 X 100 100 Percent reduction in his attendance is 125 788X100 125 Elasticity of demand E11 125100 18 092415 Lecture 8 Chap 5 Arc elasticity How to determine sensitivity to price changes over a particular part of the demand curve Technically What if we thought about things the other way What happens if ticket prices fell from 200 to 100 what would be the elasticity Same graph but different elasticity Midpoint Rule For greater accuracy use this formula E11 AQ1 o0AP1 Of QAVG Pf Pi PAVG EX PAVG AP 200 100 150 x 100 666 QAVG 75 AQ 7 8 75 x 100 133 Elasticity of demand E11 Elasticity and Total Revenue How does elasticity impact total revenue of a rm Total revenue Total revenue Price X Quantity TRPQ Consider Suppose demand is given by the equation Q6P Graphically What are the point elasticities E 1slope X PQ If E was negative 1 perhaps u would have increased price by 10 but quantity demand will is going to fall by 10 leaving total revenues invectives Elasticity CONFUSE SLOPE WITH ELASTICITY Generally Total Revenue Elasticity in Graphs can we use elasticity to describe the general nature of demand curve Perfectly Inelastic Perfectly Elastic A closer look A very small reduction in price produces a signi cant changing in quantity demand Likewise Other Elasticities What are some other common elasticites of demand Cross price Elasticity The degree to which quantity demanded of good X changes when price of good Y changes E12 AQl AP2 Which can be expressed as AQllAPZ PZQl Interpreting cross price elasticity E12 gt Osubstitutes E12 lt 0complements E12 Ogoods are unrelated Income Elasticity the degree to which quantity demanded of good X changes when income M changes ElM AQl AM Which can be expressed as AQllAM MQl Interpreting income elasticity ElM gt Onormal ElM lt Oinferior Second law of demand Chap 54 The 2rml law of demand ls more elastic in the long run Aftermath Government ultimately relented and allowed prices to rise What happened Eventually individuals substituted out of gasoline by insulating their home buying smaller cars and the like Even though gasoline prices later fell people didn t undo these substitutions long run changes are slow but tend to be permanent Observations Higher prices led to a long run reduction in quantity demanded effectively an elastic response Substitutes become increasingly viable over time Summary Arc elasticity measures the sensitivity to changes in price over a portion of a demand curve Elasticity affects total revenue of the rm Demand is more elastic in the longrun 092915 Chap 7 Costs Misconception Broken window fallacy Sunk cost Two Types of Cost 1 Historical cost accounting major what you paid for something amount u paid for something thinking about direct expenses or expenditures Do not explain behavior 2 Opportunity cost What explains behavior PRICNLCPE 4 value of one s highest forsaken alternative Did u know Cost depends on alternatives Alternatives require an action to be taken Keeping a gifts incurs a cost How to add up costs Sometimes the highest forsaken alternative is a collection of smaller sacri ces Ex what is the cost of a hamburger if the price is 350 but u have to wait an hour in line Sacri ces 13 or something bec u r waiting Cost is not a bad Rising costs is sometimes good Broken window Fallacy Application Govt cannot create jobs Disastrous and calamities cannot create economic activity Wars cannot create employment Sunk costs and ordinary costs chap 74 different types of cost 1 Sunk cost actions involving sacri ces that have no salvageable option Costs that cannot be recovered No barrier on your decisions going forward Ex rental payments advertising tickets lmplication sunk costs should be irrelevant 2 Ordinary avoidable costs Costs that r not sunk Any good that can be sold on a second hand market If one expects to have a good for K years MV bene ts yr 1 bene ts yr 2 bene ts yr 3 bene tsyr K resale value MVO Used market helps Increases price of new goods due to the good s higher resale value Developers bene t by sales of used games in the form of higher prices for new goods Summary Cost is what u sacri ce not what u paid for something Think about cost as the value of one s highest forsaken alternative Cost especially sunk cost is often counter intuitive mowing the loan mom will loss cost 100115 Ch 7 Variable and xed costs Comparative advantage Production possibility frontier 3 Variable costs VC Marginal cost Costs that change as output changes Labor materials electricity 4 Fixed costs FC Costs that don t change as output changes quotLump sumquot costs Factories warehouses machinery advertisements Total cost TC the sum of variable and xed costs TCFCVC Comic factory and Store Fit the following into the table below Store building unsold inventory custom store sign brochure sold with each purchase energy bill wages materials Ordinary Sunk Avoidable Fixed Store building Custom store sign Energy bill Variable Unsold inventory Brochure sold with Wages Materials each purchase Comparative Advantage Chap 75 78 organizing productions at lowest cost 1 Absolute Advantage Ability to produce more of a good using the same amount of resources 2 Comparative Advantage Ability to produce the good at lowest cost Three person economy Consider the following production capabilities GUNS BU39ITER SUE 8 4 CHARLES 3 3 DAPHNE 1 2 Sue had more advantage in both activities Sue makes 8 guns she sacri ces 4 unites of butter Sue scari es 12 units of butter for every gun Charles sacri ces 1 unit of butter for every gun Charles sacri ces 2 units of butter for every gun Comparative Adv If sue makes 4 unit of butter she sacri ces 8 gun Sue sacri ces 2 guns for everything unit of butter Charles sacri ces l gun for every unit of butter Daphne sacri ces 12 a gun for every unit of butter Production Possibly FrontierPPF Shows all the combinations of goods that can be produced by an economy graph Shifting the PPF if becoming more productive in making guns graph Marginal cost MC the added cost to produce one more unit of a good MC TC Q Variable cost is to the sum of the marginal cost The Marginal Cost Curve How to model the MC of a society Butter Scari ed SUE 12 CHARLES N 39 DAPHNE Graphically Generally Upward sloping MC Society uses ppl to their best use rst As society s objectives change ppl are reallocated as necessary to their secondbest uses This drives up costs upward sloping MC Application The Firm Firms use inputs capital labor to increase output inputs need to be reallocated driving up costs Econ 2306 Chap1 Economics is A particular way of thinking about behavior people have objectives and they tend to choose the best way to achieve them Three Characteristics of Economics 1 SCIENCE models assumptions 2 ART good and bad explanations intuition 3 RELIGION take model on faith all individuals are fundamentally the same Chap2 All individuals are always motivated by GREED What is max Nonsatiation more is preferred to less A good is something that maximizers want quotutility maximizationquot it is something of value Value what you re willing to pay for something Friend s episode quotthere s no unsel sh good deedsquot Why Maximization 1SCARCITY ppl will demand more than what is available 2 EQUILIBRIUM state where no one wants to changes their behavior no money left on the table Ex traf c patterns boy bands lines at the market IMPLICATION 1 ECONOMIC PROFIT Tl n Total Revenue Total Cost O Pro ts easy money or above normal Returns changes behavior IMPLICATION 2 ECONOMIC POLICY quotMagicalquot policy solutions do not exist lnstitutions exist because they make sense economically The world around us is optimal world is not perfect we r doing our best we can What do we maximize Consumers maximize utility Firms maximize pro ts Maximization isn t good or right it just works SUMMARY People are greedy No other explanations allowed Maximizers want things of value goods Maximization leads to scarcity and equilibrium Chap 3 Substitution applications marginal value trade Y 2X l Substitution principle 2 Everyone has there price nothing is sacred Ex buy text book or not Attend class or not Work vs leisure Play video games or study Choice of soft drinks Our willingness to substitute or tradeoff is Voluntary universal not without sacri ce There may be social sanctions to substitution Sometimes we bind ourselves not to substitute U wont substitution when it comes to important things Gas safety healthcare pharmaceuticals other ppls lives Needs is not an economic concept only WANTS No quotpriority of consumption ppl consume a variety of goods even at low income Other Implications Willingness to substitute is the only observable measure of value quotAbilityquot vs Willingness to pay Marginal Value MV The maximum amount of one good an individual is willing to sacri ce to obtain one more unit of another good MV is the maximum willingness to pay for the next unit of a good Suppose Skippy and Myrtle are indifferent between the bundles SUMMARY People are constantly faced with tradeoffs Substitution is voluntary and is our only true measure of value Trade is voluntary and generally makes both parties better off 090315 Lecture 3 Ch 4 Diminishing Marginal Value MV and TV The Law of Demand Demand Curves What motivates individual behavior PRINCPLE 3 Diminishing marginal value The more you have of something the less you are willing to pay for it No exceptions Diminishing Marginal Value is universal Related concept TOTAL VALUE TV the sum of the marginal values the maximum one is willing to pay for a particular quantity of a good EXAPMLE I love oranges Suppose the value I put on the rst unit of oranges is 475 The second is 425 The third is 375 and the fourth is 325 What is the Total Value I put on consuming 4 units TV MV1 MV2 MV3 MV4 475 425 375 325 16 MV and TV Marginal value is the change in total value arising from a change in quantity Margin is always a slope MV ATotal Value A Quantity ATVAQ SUMMARY These three principles describe our preferences Maximization Substitution Diminishing Marginal Value DMV 1 Law of Demand There is an inverse neg relationship btw price and quantity demanded 1 Finding Quantity Demanded at a given price STEP 1 move horizontally across until u meet the demand curve STEP 2 move downwards to the xaxis Graph Example suppose Jane s demand curve is given by Q 10 P How many units does Jane buy w hen the price is 2 i Create T chart Q 10 P A suitable tchart might look like chart ii Graph Demand Curve Plotting out tchart values graph 2 Find marginal value for the next unit of a good STEP 1 go up vertically to the demand curve STEP 2 move horizontally across to the yaxis Graph EXAMPLE Suppose Joe s demand curve is given by Q 10 12 P How much is Joe willing to pay for the 4th unit i Create T chart Q 10 12 P lfQ4 what is P 410 12P 6 P 12P iii Graph Demand Curve Plotting the values in our tchart SUMMARY The more we have something the less we value it When the price of something goes up we consume less of it This applies to all things universal 090815 Lecture 4 Ch 4 Applications Practice Moral Hazard Relative Prices Maximization Every point on the demand curve is an optimal choice it re ects a process of maximization Another graph Substitution we substitute away from good Y towards more of good X when price of X falls graph Diminishing marginal value The maximum price one is willing to pay for each added unit diminishes the more that is consumed There is no Exceptions To deny the quotlaw of demandquot is to deny the principle of substation Food GasoHne Seat belts price of driving dangerously will go down if we make people more vulnerable bec there is protection divorce the laws change from the 60 s Fault from no fault something was committed from your other half Research Doug Allen nds that a 100200 increase in welfare bene ts per year Increases the probability that a woman on welfare is a single parent by 5 percent Increases the probability that a woman will divorce by 1 percent what about guns Lott 1997 found that controlling for other possible factors the introduction of concealed carry laws is associated with 8 reduction in murder 5 red ln rape 3red In robbery 7 red In aggravated assault 091015 Moral Hazard When ppl s action cannot be observed ppl tend to behave in an opportunistic manner EXAMPLES Insurance fraud Moral hazard a dedication and respecting it Moral Hazard The dysfunctional behavior arising from moral hazard underscores the importance of monitoring LAW OF DEMAND Applications Chap 4246 relative prices Relative price price of goodsX in terms of the of other Y one must sacri ce to buy it Relative Price of Good XPxPy EXAMPLE Pmovie10 Pfootball 50 The relative price of a movie PmoviePfootball game 1050 15 football games 4 every movie consumed 15 football games r sacri ced Suppose Price of movie increased to 15 but football games also increased to 90 Pmovie Pfootball game 509016 football games Notice the relative s price of movies is actually falling even though nominal price of movies is increasing Relatives vs Nominal prices Relative prices help us understand behavior Nominal prices sticker prices posted prices etc do not EXAMPLE PhPI PhPl2150 133 low quality apples Graphically 3ml law of demand When a xed charge has been applied to a good that varies in quality consumers will substitute towards the higher quality good Bonus question Royal with cheese Relatives prices maybe Y the quality of gas in Europe so much higher than in the US Pay a lot in taxes Law of demand Applications Chap 47 MV versus TV MV versus TV to think about this question we need to distinguish btw marginal and total value QlOP MV vs TV As we consume of a good total value increases but marginal value falls The diamond water paradox arises bec ppl make their decisions on the margin not based on total value
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