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PSU ECON 102 - Final Exam review

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Final Exam reviewChapter 4Price controls- Price Ceiling (legal maximum price)o Only effective if set below the market priceo Rent control – price ceiling on rents municipalities. Losers- owners of rental properties, winners- tenants that occupy rent-controlled housing unitso Creates a shortage - in free competitive markets the price should rise in response to shortageo Price system is not allowed to correct shortageo Possible effect – black market – when the price-controlled good is illegally sold ata price higher than the legal price ceiling- Price floors (legal minimum price)o Only effective if set about the market priceo Creates a surplus – would cause price to fall until equilibrium is restoredo This won’t happen in government-imposed price floor - government may buy the surplus and keep it in government storage facilitieso Winners from agricultural price supports – domestic producers, foreign consumers. Losers- foreign producers, domestic consumers, taxpayers- Producer surplus – difference between the minimum price the buyer is willing to pay and what she actually pays - Consumer surplus - difference between the maximum price the seller is willing to accept and what they actually receive - Deadweight loss – the loss in total surplus resulting from the market distortions Chapter 5- Public goods - o Non rival consumption – public goods can be used by more people at no additional cost w/o depriving others of any service of the good.o Non excludable – impossible or costly to exclude those that have not paid for the good - Why is that the private sector is not expected to supply an efficient amount of a pure public good?o they would be unable to supply them for a profit. It is up to the government to decide what output of public goods is appropriate for society.- The free rider problem – a situation association with public goods when individuals presume that others will pay for the public good, so that they can escape paying for their portion w/o causing a reduction in production- Externalities – consequence of an economic activity that spills over to a 3rd partyo Negative externality – exists when an economic activity imposes a cost on third parties- Why do free markets tend to over allocate resources to the production of goods that generate external costs?o Markets only recognize private costs, therefore underestimating the true cost of producing a good or service- How could negative externality problems be resolved privately?o Coarse Theorem – negotiation leads to the socially efficient outcome regardless ofwho has the legal property rights- How can the government correct negative externalities (graphical illustration of negative externalities)?o Pigouvian tax – intended to correct an undesirable or inefficient market outcome, set equal to the social costs of a negativeexternalities o Regulations – the governmentdetermines an acceptable level ofpollution and requires companies thatexceed that level to install things likepollution abatement equipment- Positive Externalitieso Why do free markets tend to underallocate resources to the production of goods that generate external benefits?- What can the government do to correct positive externalities?o Direct financing – the government provides a per unit payment to producers of goods that create positive externalities o Production subsides/ regulations – requiring that individuals engage in certain activities, such as requiring school children to get vaccinations- Graphical illustrations of positive externalitiesChapter 19- Price elasticity of demand – how responsive the change in quantity demanded of a good is to a change in the price of the same good- Calculation of price elasticity of demand usingmidpoint method and point elasticity formula o Midpoint formula and point elasticitymethod- Interpretation of price elasticity of demand o Perfectly elastic – |Ep| = ∞, anyincrease price change will cause quantitydemanded to fall to zeroo Elastic – 1 < |Ep| < ∞, 1% change in pricecauses greater than a 1% change in quantitydemandedo Unit elastic – |Ep| = 1% change in price causes exactly a 1% change in quantity demandedo Inelastic – 0 < |Ep| < 1, 1% change in price causes less than a 1% change in quantity demanded o Perfectly Inelastic - |Ep| = 0, no matter what the price the quantity demanded will be the same- Income elasticity of demando Definition – how much the demand for a good respond to changes in income, while holding the price of a good constanto Interpretation Normal goods – as income increases, demand will increase resulting in a direct relationship- Income elasticity will be positive- Ex. Laptops, DVD player, flat screen TV’s- Luxury goods: E1 > 1- Necessities: 0 < E1< 1 Inferior goods – As income increases demand will decrease resulting in an inverse relationship- Ex. SPAM, ramen- Cross price elasticity of demando Definition – The percent change of quantity demand for one good divided by the percent change in the price for another goodo Interpretation Substitutes – cross elasticity of demand will be positive Complements – Cross elasticity of demand will be negative- Price elasticity of supplyo Definition – How responsive the quantity supplied of a good is to a change in a goods priceo Interpretation Supply elasticity tends to be positive because of the direct relationship between supply and price Supply elasticity is the producers responsiveness to a change in priceChapter 20- Important conceptso Utility – the ability of a good or service to satisfy a wanto Total utility – Utility from consuming all units of a goodo Marginal utility – the change in utility when we consume one more unit of a good or serviceo Diminishing marginal utility – the idea that as we consume more of the same good, the extra benefit of each additional unit we consume goes downo Consumer Optimum – The combination of goods and services that maximizes a consumers total utility while being faced with a limited incomeChapter 21- Economic rent o Definition – payment for the use of a resource over and above its opportunity costo Meaning – should be viewed as a payment to resource owners in excess of what would be necessary to move that resource from its current employment o Calculation – ½ x LE x (WE-WR)- Accounting profit – the difference between total revenues and explicit costs (costs that business managers must consider because they must be paid, out


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