ECON 251 Exam II Study Guide
ECON 251 Exam II Study Guide ECON 251
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This 9 page Study Guide was uploaded by Abby Frazier on Monday April 4, 2016. The Study Guide belongs to ECON 251 at Purdue University taught by Kelly Blanchard in Fall. Since its upload, it has received 549 views. For similar materials see Microeconomics in Economcs at Purdue University.
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Date Created: 04/04/16
ECON 116 Exam II Study Guide 1 ECON 251 Exam II Study Guide: Chapter 7: Key Points: 1. Describe the effects of sales taxes and excise taxes, determine who pays these taxes, and explain why taxes create inefficiencies • A sales tax or an excise tax raises the price of the good or service that is taxed but usually by less than the tax—the buyer pays only part of the tax • The less elastic demand and the more elastic supply, the greater is the price increase, the smaller is the quantity decrease, and the larger is the share of the tac paid by the buyer • If demand is perfectly elastic or supply is perfectly inelastic, the seller pays all of the tax. And if demand is perfectly inelastic or supply is perfectly elastic, the buyer pays all of the tax • Taxes create inefficiency by driving a wedge between marginal benefit and marginal cost and creating a deadweight loss 2. Describe the effects of income taxes and social security taxes, determine who pays these taxes, and explain which taxes create the greatest inefficiency • Taxes can be progressive (the average tax rate rises with income), proportional (the average tax rate is constant), or regressive (the average tac rate falls with income • The U.S. income tax is progressive • The shares of the income tax paid by the firms and household’s, depend on the elasticity of demand and the elasticity of supply of the factors of production • The elasticities of demand and supply, not Congress, determine who pays the income tax and who pays the social security tax • The more elastic is either demand or supply, the greater is the excess burden of a tax 3. Review ideas about the fairness of the tax system • The two main principles of fairness of taxes—the benefits principle and the ability-to- pay principle—do not deliver universally accepted standards of fairness, and vertical equity and horizontal equity can come into conflict Key Terms: • ability-to-pay principle = proposition that people should pay taxes according to how easily they can bear the burden • average tax rate = the percentage of income that is paid in tax—less than the marginal tax rate • benefits principle = proposition that people should pay taxes equal to the benefits they receive from public services • excess burden = the dead weight loss that arises from tax • horizontal equity = if taxes are based on the ability to pay, taxpayers with the same ability to pay should pay the same taxes • marginal tax rate = the percentage of an additional dollar of income that is paid in tax ECON 116 Exam II Study Guide 2 • payroll tax = a tax on employers based on the wages they pay their workers • progressive tax = when the average tax rate increases as income increases; the personal income tax • proportional tax = same average tax rate at all income levels • regressive tax = decreasing average tax rate as income decreases • taxable income = the total income minus a personal exemption an a standard deduction • tax incidence = the division of the burden of a tax between the buyer and the seller • vertical equity = the requirement that tax payers with a greater ability to pay bear a greater share of the taxes Chapter 9: Key Points: 1. Household Consumption Choices • A household’s choices are determined by its consumption possibilities and preferences • A household’s consumption possibilities are constrained by its income and by the prices of the goods and services. Some combination of goods and services are affordable, and some are not affordable • A household’s preferences can be described by marginal utility • The key assumption of marginal utility theory is that the marginal utility of a good or service decreases as the consumption of the good or service increases • The marginal utility theory assumes that people buy the affordable combination of goods and services that maximizes their total utility 2. Maximizing Utility • Total utility is maximized with all the available income is spent and when the marginal utility per dollar spend on each good is equal • If the marginal utility per dollar spend on good A exceeds that on good B, total utility increases if the quantity purchased of good A increases and the quantity of good B decreases 3. Predictions of Marginal Utility Theory • Marginal utility theory predicts the law of demand. That is, other things remain the same, the higher the price of a good, the smaller is the quantity demanded of that good • Marginal utility theory also predicts that other things remaining the same, the larger the consumer’s income, the larger is the quantity demanded of a normal good • The market demand curve is found by summing horizontally all the individual demand curves 4. Efficiency, Price, and Value • When a consumer maximizes utility, he or she is using resources efficiently • Marginal utility theory resolves the paradox of value • When we talk loosely about value, we are thinking of total utility or consumer surplus. But price is related to marginal utility ECON 116 Exam II Study Guide 3 • Water, which we consume in large amounts, has a high total utility and a large consumer surplus, but the price of water is low and the marginal utility from water is low • Diamonds, which we consume in small amounts, have a low total utility and a small consumer surplus, but the price of a diamond is high and the marginal utility from diamonds is high Key Terms: • Budget line = describes the limits to its consumption choices • consumer equilibrium = situation in which a consumer has allocated all of his or her available income in the way that, given the price of goods and services, maximizes his or her total utility • diminishing marginal utility = decrease in marginal utility as the quantity of the good consumed increases • marginal utility = the change in total utility that results from a one-unit in the quantity of a good consumed • marginal utility per dollar spent = the marginal utility from a good divided by its price • market demand = the relationship between the total quantity demanded of a good and its price • real income = the household’s income expressed as a quantity of goods the household can afford to buy • relative price = the price of one good divided by the price of another • total utility = the total benefit that a person gets from the consumption of goods and services • utility = the benefit or satisfaction that a person gets from the consumption of a good or service Chapter 10: Key Points: 1. The short run versus the long run from a firm’s perspective • The short run for a frim is the period during which at lease one input, such as plant size, cannot be altered • Inputs that cannot be changed in the short run are fixed inputs, whereas factors of production may be adjusted in the short run are variable inputs • The long run is a period of time in which a firm may vary all factors of production 2. The law of diminishing marginal returns • The production function is the relationship between inputs and the maximum physical output, or the total product, that a firm can produce • Typically, a firms marginal physical product—the physical output resulting from the addition of one more unit of a variable factor of production that it employs • Eventually, as the firm adds more and more units of the variable input, the marginal physical product begins to decline—the law of diminishing returns ECON 116 Exam II Study Guide 4 3. A firm’s short-run cost curves • The expenses for a firm’s fixed inputs are its fixed costs, and the expenses for its variable inputs are variable costs • The total costs of a firm are the sum of its fixed costs and variable costs • Dividing fixed costs by various possible output levels traces out the firm’s average fixed cost curve, which slopes downward because divided fixed costs by a larder total product yields a lower average fixed cost • Average variable cost equals total variable cost divided by total product • Average total cost equals total cost divided by total product • Computing average variable and average total cost yields U-shaped curves • Marginal cost is the change in total cost resulting from a one-unit change in production • A firm’s marginal costs typically decline as the firm produces the first few units of output, but at the point of diminishing marginal returns, the marginal cost curve also interests the minimum points of the average variable cost curve and average total cost curve 4. A firm’s long-run cost curves • Over a firm’s long-run or planning, horizon, it can choose all factors of production, including plant size—thus can choose a long-run average cost curve • The long run average cost curve is U-shaped and traced out by the short-run average cost curves corresponding to various plant sizes 5. Economies and Diseconomies of scale and a firm’s minimum efficient scale • Along the downward-sloping range of a firm’s long-run average cost curve, the firm experiences economies of scale, meaning that its long-run production costs decline as it increases its plant size and thereby raises its output scale • In contrast, along the upward-sloping portion of long run average cost curve, the firm encounters diseconomies of scale, so that its long-run costs of production rise as it increases its output scale • The minimum point of the long-run average cost curve occurs at the firm’s minimum efficient scale—which is the lowest rate of output at which the firm can achieve minimum long-run cost Key Terms: • average fixed costs = total fixed costs divided by the number of units produced • average physical product = total product divided by the variable input • average total costs = total costs divided by the number of units produced—sometimes called average per-unit total costs • average variable costs = total variable costs divided by the number of units produced • constant returns to scale = the long-run average cost curve is at its minimum point, such that an increase in scale and production does not change unit costs—otherwise there is no change in long-run average costs when output increases • diseconomies of scale = where the long-run average cost curve slopes upward • economies of scale = where the long-run average cost curve slopes downward ECON 116 Exam II Study Guide 5 • fixed costs = costs that do not vary with output; include things such as rent on a building—these costs are fixed for a certain period of time; in the long run they are variable • law of diminishing (marginal) returns = the observation that after some point, successive equal sized increases in a variable factor of production, such as labor, added to fixed factors of production, will result in smaller increases in output • long run = the time period during which all factors of production can be varied • long-run average cost curve = the local points representing the minimum unit cost of producing any given rate of output, given current technology and resource prices • marginal costs = the change in total costs due to a one-unit change in production rate • marginal physical product = the physical out put that is due to the addition of one more unit of a variable factor of production—the change in total product occurring when a variable input is increased and all other inputs are held constant; also called marginal product or marginal return • minimum efficient scale (MES) = the output rate when economies of scale and constant economies of scale start—the lowest rate of output per unit time at which long0run average costs for a particular firm are at a minimum • planning curve = the various average costs attainable at the planning stage of firm’s decision making—otherwise known as the long-run average cost curve • planning horizon = the long run, during which all inputs are variable—also known as the long-run curve • plant size = the physical size of the factories that a firm owns and operates to produce its output—plant size can be defined by square footage, maximum physical capacity, and other physical measures • production = any activity that results in the conversion of resources into products that can be used in consumption • production function = the relationship between inputs and maximum physical output—a production function is a technological, not an economic, relationship • short run = the time period during which at least one input, such as plant size, cannot be changed • total costs = the sum of total fixed costs and total variable costs • variable costs = costs that vary with the rate of production—they include wages paid to workers and purchases of materials Chapter 11: Key Points: 1. Explain a perfectly competitive firm’s profit-maximizing choices and derive its supply curve • A perfectly competitive firm is a price taker • Marginal revenue equals price • The firm produces the output at which price equals marginal cost • If the price is less than minimum average variable cost, the firm temporarily shuts down ECON 116 Exam II Study Guide 6 • A firm’s supply curve is the upward-sloping part of its marginal cost curve above minimum average variable cost and the vertical axis at all prices below minimum average variable cost 2. Explain how output, price, and profit are determined in the short run • Market demand and market supply determine price • Firms choose the quantity to produce that maximizes profit, which is the quantity at which marginal cost equals price • In short-run equilibrium, a firm can make an economic profit or incur an economic loss 3. Explain how output, price, and profit are determined in the short run • Economic profit induces entry, which increases supply and lowers price and profit— economic loss induces exit, which decreases supply raises price, and lowers the losses • In the long run, economic profit is zero and there is no entry or exit • The long-run effect of a permanent increase in demand on price depends on whether there are external economies (price falls) or external diseconomies (price remains constant) • New technologies increase supply and in the long run lower the price and increase the quantity Key Terms: • external diseconomies = factors beyond the control of an individual firm that lower its costs as the market output increases • external economies = factors outside the control of a firm that raise the firm’s costs as market output increases • long-run market supply curve = a curve that shows the relationship between the quantity supplied and the price when the number of firms changes so that each firm earns zero economic profit • marginal revenue = the change in total revenue that results from a one-unit increase in the quantity sold • monopolistic competition = a market in which a large number of firms compete by making similar but slightly different products • monopoly = a market for a good or service that has no close substitutes and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms • oligopoly = a market in which a small number of firms compete • perfect competition = a market in which there are many firms, each selling an identical product—many buyers, no restrictions on the entry of new firms into the industry, no advantage to established firms, and buyers and sellers are well informed about prices • price taker = a firm that cannot influence the price of the good or service that it produces • shutdown point = the output and price at which the firm just covers its total variable cost Chapter 12: ECON 116 Exam II Study Guide 7 Key Points: 1. Explain how monopoly arises and distinguish between single-price monopoly and price- discriminating monopoly • A monopoly is a market with a singly supplier or a good or service that has no close substitutes and in which legal or natural barriers to entry prevent competition • A monopoly can price discriminate when there is no resale possibility • Where resale is possible, firm charges a single price 2. Explain how a single-price monopoly determines its output and price • The demand for a monopoly’s output is the market demand, and a single price monopoly’s marginal revenue is less than price • A monopoly maximizes profit by producing the output at which marginal revenue equals marginal cost and by charging the maximum price that consumers are willing to pay for that output 3. Compare the performance of a single-price monopoly with that of perfect competition • A single-price monopoly charges a higher price and produces a smaller quantity than does a perfectly competitive market and creates a deadweight loss • Monopoly imposes a loss on society that equals its deadweight loss plus the cost of the resources devoted to rent seeking 4. Explain how price discrimination increases profit • Perfect price discrimination charges a different price for each unit sold, obtains the maximum price that each consumer is willing to pay for each unit, and redistributes the entire consumer surplus to the monopoly • With perfect price discrimination, the monopoly produces the same output as would a perfectly competitive market, but rent seeking uses some pf the surplus 5. Explain how monopoly regulation influences output, price, economic profit, and efficiency • Natural monopolies can produce at a lower price than competitive firms can, and monopolies might be more innovative than competitive firms • Efficient regulation requires that price equal marginal cost, but for a natural monopoly, such a price is less than average cost • Average cost pricing is a rule that covers a firm’s costs and provides a normal profit but is inefficient Key Terms: • average cost pricing rule = a price rule for a natural monopoly that sets the price equal to average cost and enables the firm to cover its costs and earn a normal profit • barrier to entry = a natural or legal constraint that protects a firm from competitors • legal monopoly = a market in which competition and entry are restricted by concentration of ownership of a natural resource or by granting of public franchise, government license, patent or copyright • marginal cost pricing rule = a price rule for natural monopoly that sets price equal to marginal cost • natural monopoly = a monopoly that arises because one firm can meet the entire market demand at a lower price than two or more firms could ECON 116 Exam II Study Guide 8 • perfect price discrimination = price discrimination that extracts the entire consumer surplus by charging the highest price that consumers are willing to pay for each unit • price=discriminating monopoly = a monopoly that is able to sell different units of a good or service for different prices • rent seeking = the act of obtaining special treatment by the government to create economic profit or to divert consumer surplus or producer surplus away from others • single-price monopoly = a monopoly that is able to sell different units of a good or service for different prices Equations to remember for Exam II: Lecture 12: Income = PxQx + PyQy; PxQy = spending on good x, PyQy = spe nding on good y Marginal utility (mu) per dollar spent = Mu/p Lecture 13: Consumer equilibrium: Mux/Px = Muy/Py Marginal benefit = y-coordinate of demand Marginal rate of substitution = the amount of good y you are willing to give up for one more unit of good x; the absolute value of the slope Lecture 14: MRS = Mux/Muy ß maximum utility where budget line crosses Indifference Curve ECON 116 Exam II Study Guide 9 Lecture 15: Accounting profit = revenue – explicit costs Economic profit = revenue- explicit costs – implicit costs Marginal Product (MP) = ∆Q/∆L Average product = MP /total resourcLs = Q/L Total cost (TC) = Fixed Cost (FC) + Variable Cost (VC) Average fixed cost (AFC) = FC/Q Average variable cost (AVC) = VC/Q Average total cost (ATC) = TC/Q Lecture 16: Marginal Cost (MC) = ∆TC/∆Q = ∆VC/∆Q = wage/MP L concentration ratio = percent of sales accounted for by the four largest firms in the industry Herfindahl-Hirschman Index (HHI) = sum of squared market shares of top 50 firms Lecture 17: Profit = TR – TC = q(P – ATC) Marginal revenue = ∆TR/∆q E = |%∆Q |/|%∆P| Lecture 18: Consumer Surplus= area below demand and above the price Producer Surplus = area below the price and above the supply
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