ECON 1200: EXAM 1
254 Cards in this Set
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economics is
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the study of how people manage/allocate scarce resources
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microeconomics
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study of human choice in context of markets
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macroeconomics
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study of economy-wide phenomena
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scarcity
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limited nature of resources
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scarcity exists because
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people have unlimited wants but limited resources
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rational choice means
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people use all available information to make choices that are in own best self interest
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economics:
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calculated self-interested people operating under conditions of scarcity
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marginal analysis
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comparison of extra (marginal) costs and extra (marginal) benefits of a particular course of action
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rational individuals choose the action where...
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marginal benefit > marginal cost
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as a course of action advances...
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MB falls, MC rises
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an action should be advanced as long as..
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MB > MC, stopping when MB = MC
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opportunity cost
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value of what must be given up in order to gain something else
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opportunity costs exist because..
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all decisions involve tradeoffs
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centrally planned economy
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gov decides how to allocate resources
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result of centrally planned econ
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not successful in producing low cost, high quality goods and services
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market economy
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decisions of households and firms interacting in market allocate resources
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market econ consumers
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determine what goods and services will be produced
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market econ firms
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those that produce highest quality at lowest cost are the ones that will produce and sell goods and services
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market economies are..
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highly efficient
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efficiency
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firms produce at lowest cost, production is in accordance with consumer preference, no resource wasted, prosperity maximized
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markets are usually a good way to...
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organize economic activity
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which consumers will receive the goods in a market econ?
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those who are most willing and able to buy goods and services
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equity
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the fair distribution of econ prosperity
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market economies are good at..
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producing goods and services efficiently
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market economies are not so good at..
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distributing them equitably
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in market economies, gov can sometimes
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improve market outcomes
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in market economies, there is often a tradeoff between
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efficiency and equity
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most economies in the world are
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mixed economies, because they exhibit some degree of gov intervention
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positive analysis
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concerned with what is (objective)
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normative analysis
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concerned with what ought to be (subjective)
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what kind of analysis do we use in economics?
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positive
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positive analysis can show...
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consequences of particular policy
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positive analysis cannot show...
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whether the particular policy is good or bad
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tool used to conduct positive analysis
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economic model
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Production Possibilities Frontier (PPF)
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curve showing max attainable combos of 2 products that can be produced with available resources and current tech
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PPF - combos on or inside the frontier are..
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attainable with the available resources and current tech
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PPF - combos on the frontier are..
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efficient
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PPF - combos inside the frontier are...
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inefficient
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PPF - combos beyond frontier are...
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unattainable - current resources and tech do not support these levels of output
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use PPF to..
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illustrate tradeoffs and opportunity cost in terms of quantity of one good that must be given up to produce more of other good
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linear PPF exhibits
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constant opportunity cost
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constant opportunity cost seen in production processes where...
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resources are equally well-suited to producing more than one good
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a more realistic PPF is..
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concave
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concave PPF model exhibits
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increasing opportunity cost
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why do opportunity costs increase?
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specialization of resources involved with many production processes
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when technological progress increases productivity of available resources...
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PPF shifts outward
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when war, natural disasters, and significant outward migration of populations decrease a firm's productive capacity...
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PPF shifts inward
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circular flow model
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visual model of market econ which shows how players in econ interact in markets
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market
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group of buyers and sellers of good or service and the institution or arrangement by which they come together to trade
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buyers are
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source of demand
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sellers are
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source of supply
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households and firms can be
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either source of demand or supply
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product market
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market for goods and services
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who buys/demands in product market?
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households
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who sells/supplies in product market?
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firms
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factor market
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market for inputs into production processes of goods and service
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who buys/demands in factor market?
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firms
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who sells/supplies in factor market?
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households
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absolute production advantage
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ability to produce a good using fewer inputs than a competitor
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comparative production advantage
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ability to produce good at lower opportunity cost than competitor
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specialization in the activity in which a producer has a comparative advantage will...
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increase productivity
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opportunity cost formula
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sacrifice / gain
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consumption rises when
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countries specialize in producing that good for which they have a comparative advantage and trade for what they do not produce
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terms of trade
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price at which one good trades for another
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gains from trade possible when
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per unit term of trade lies between range of opportunity costs
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perfectly competitive market has 3 conditions:
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many buyers and sellers; all firms selling identical products; no barriers to new firms entering the market
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Law of Demand
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holding everything else constant, there is an inverse relationship between price and quantity demanded
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what explains Law of Demand?
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substitution and income effect
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substitution effect
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change in quantity demanded of a good resulting from making the good more or less expensive than substitute goods
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income effect
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change in quantity demanded of a good resulting from change in price on consumers' purchasing power
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purchasing power
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value of a currency expressed in terms of amount of good or service that one unit of money can buy
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move up or down demand curve depicts
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change in quantity demanded
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shift in demand curve depicts
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change in demand
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normal good
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a good for which demand increases as income rises and vice versa
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inferior good
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a good for which demand increases as income falls and vice versa
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substitutes
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goods and services that can be used for the same purpose
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relationship between substitute goods
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increase in price of A --> decrease quantity demanded of A --> increase demand for B
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complements
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goods and services that are used together
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relationship between complementary goods
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increase in price of A --> decrease demand for both A and B
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population growth effect on # of buyers in market
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increases # buyers in market
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effect of population growth on demand
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demand for many goods will increase
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Law of Supply
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holding everything else constant, there is a direct relationship between price and quantity supplied
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when price of a product rises, quantity supplied will
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increase
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when price of product falls, quantity supplied will
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decrease
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movement along supply curve in response to change in price is described as
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change in quantity supplied
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if any factor affecting supply other than price changes, supply curve will _____, described as
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shift; change in supply
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prices of inputs into production process influence
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profitability of production
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if price of input rises
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total cost of production rises, profitability reduced
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if price of input rises, supply...
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decreases, depicted as shift to the left of the supply curve
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if price of input falls
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total cost of production falls, profitability increases
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if price of input falls, supply...
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increases, depicted as shift to right of supply curve
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advancements in tech
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reduce cost of production and increase profitability
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tech advancements shift supply curve
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right
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substitutes in production
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single produces several products
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if one substitute in production experiences rise in market price, then
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profitability of producing that product rises, supply curve shifts right
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when new firms enter a market
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supply increases, supply curve shifts right
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when firms exit market
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supply decreases, supply curve shifts left
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if firm expects market price of product will be higher in the future, it faces incentive to
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reduce supply in present, increase supply in future
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free market
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prices coordinate actions of buyers and sellers, shortages or surpluses eliminated, prosperity in society maximized
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market mechanism
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process by which players in market respond to flexible prices --> optimal market outcomes are achieved
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market equilibrium
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point of intersection of demand and supply curves; where quantity demanded = quantity supplied
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in a free market, market mechanism drives market toward
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equilibrium
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in reality, equilibrium is achieved as rational people respond to
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incentives
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disequilibrium quantity when actual price > equilibrium price
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quantity supplied > quantity demanded --> market surplus
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disequilibrium effect on firms when actual price > equilibrium price
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incentive to lower prices in order to encourage sales and generate revenue
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when actual price > equilibrium price, downward pressure on price exists as long as
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surplus exists
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when actual price > equilibrium price, price will stop falling when
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quantity supplied and quantity demanded are equal, which is when price is equal to equilibrium level
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disequilibrium quantity when actual price < equilibrium price
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quantity demanded > quantity supplied --> market shortage
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disequilibrium effect on firms when actual price < equilibrium price
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incentive to raise prices b/c they know buyers will be willing to pay more
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when actual price < equilibrium price, upward pressure on price will exist as long as
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shortage exists
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when actual price < equilibrium price, price will stop rising when
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quantity supplied = quantity demanded, price = eq. level
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Law of Demand and Supply
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price of good or service will adjust so that quantity demanded = quantity supplied
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relationship between price and quantity demanded?
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negative
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relationship between price and quantity supplied?
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positive
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elasticity
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measure of responsiveness of quantity demanded and supplied to a change in one of its determinants
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Price Elasticity of Demand (PED)
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measure of responsiveness of quantity demanded to a change in price
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PED formula
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|(% change in quantity demanded)/(% change in price)|
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midpoint method: % change is
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(A-B)/((A+B)/2)
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PED > 1
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demand is elastic; quantity demanded changes proportionately more than price
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PED < 1
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demand is inelastic; quantity demanded changes proportionately less than price
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vertical demand curve
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PED = 0
perfectly inelastic
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horizontal demand curve
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PED = infinity
perfectly elastic
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PED = 1
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demand is unit elastic; quantity demanded changes proportionately the same amount as price
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availability of close subs -->
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more elastic demand
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necessities
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more inelastic in demand
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luxuries
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more elastic in demand
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broady defined market (food)
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more inelastic in demand
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narrowly defined market (bananas)
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elastic in demand
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goods in the long run
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more elastic in demand
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goods in the short run
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more inelastic in demand
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if price of good requires only small fraction of avg consumer's total budget, demand will be
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more inelastic
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total revenue =
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price per unit X quantity sold
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for demand that is inelastic, price and total revenue move in
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same direction
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for demand that is price elastic, price and total revenue move in
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opposite directions
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for demand that is unit elastic, change in price will
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not cause change in total revenue
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total revenue will rise over
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the elastic range of the demand curve
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total revenue will reach max at
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point of unit elasticity
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total revenue will fall over
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inelastic range of demand curve
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a firm or economy that is operating on its production possibilities frontier is
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efficient
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market economy is considered ___ because
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the best way to organize economic activity; efficient outcome (consumer and producer benefit is maximized)
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willingness to pay
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maximum amount a buyer is willing to pay for a good or service
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marginal benefit (MB)
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benefit received by buyer from consuming one unit of a good or service
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consumer surplus
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difference between consumer's MB of good or service and the price actually paid
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if MB > price, consumer will
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buy
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if MB < price, consumer will
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not buy
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if MB = P, consumer is
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indifferent
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MB of every consumer is reflected in
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demand curve
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consumer surplus for the entire market =
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area under demand curve and above price
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2 components of increase in consumer surplus when price falls
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greater difference between MB of existing buyers and price; surplus which belongs to new consumers that can now participate b/c price has dropped below their MB
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willingness to supply
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minimum price firm is willing to accept on the sale of one unit of good or service
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marginal cost (MC)
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additional cost incurred by firm by producing one additional unit of good or service
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MC =
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minimum acceptable price
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MB =
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willingness to pay
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producer surplus
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difference between price a firm receives for one unit of product and the MC of that unit
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if price > MC, producer will
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supply
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if price < MC, producer will
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not supply
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if price = MC, producer
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is indifferent
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MC of every producer is reflected in
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supply curve
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producer surplus for entire market =
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area above supply curve and below price
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2 components of increase in producer surplus if price rises
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greater difference between price and MC of producers already participating; surplus belonging to new producers who have entered the market b/c price has risen above their MC
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efficiency exists when
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benefits to participants in a market have been maximized
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total economic surplus (TES) =
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consumer surplus + producer surplus
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efficiency =
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max TES
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deadweight loss
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reduction in TES resulting from market not being in equilibrium
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market equilibrium is considered efficient because
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it provides the max level of TES
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trading in a market should take place as long as
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MB > MC until MB = MC
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market is efficient when MB of last unit traded =
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MC of its production
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output is inefficiently low when
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output is below equilibrium output; MB > MC
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output is inefficiently high when
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output is greater than equilibrium output; MB < MC
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economic efficiency is a market outcome in which
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max TES; MB last unit produced = MC of production
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market equilibrium is efficient because it
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maximizes total economic surplus
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price floor
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legal minimum on price designed to help producers
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binding price floor is set greater than
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the equilibrium price
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price ceiling
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legal max on price designed to help consumers
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binding price ceiling is set less than
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the equilibrium price
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producer tax effect on supply curve
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supply curve will shift upward by size of tax
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tax revenue =
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size of tax X # units sold
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tax on buyers effects demand curve by
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shifting demand curve down by size of tax
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tax incidence
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manner in which burden of tax is shared among participants in market
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burden of tax will fall more heavily on side of market (D or S) that is
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less elastic
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burden of a tax can be measured by how much
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price changes for each market participants
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externality
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cost or benefit that affects someone or something who is not directly involved in the production or consumption of a good or service
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negative externality
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cost or adverse effect imposed on society by production of good or service
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positive externality
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additional benefit conferred on members of society who are not direct consumers of good or service
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when externality is present, market equilibrium is
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no longer efficient because it does not maximize welfare of all people and entities affected by production and consumption
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market equilibria only taking into account MB and MC that are
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internal, private, to market
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demand curve reflects only
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private MB
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supply curve reflects only
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private MC
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when externality is present, gov intervention can potentially
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increase market efficiency
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private MC of production is
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cost incurred by firm to produce each unit of output, reflected in supply curve
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external MC of production is
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cost imposed on certain members of society or the environment
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social MC is
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sum of private MC and external MC at each unit of output
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when negative externality is present, private market will ____ or _____
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produce too much of good or service; sell it a price that is too low
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when negative externality is present, quantity of output produced at private market equilibrium has characteristic of
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social MC > MB
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tax charged to sellers of good or service can force private market to
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internalize external costs of production and reduce output to efficient level
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when a positive externality is present, private market will
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consume too little of good or service
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when positive externality is present, quantity of output produced at private market equilibrium has characteristic of
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social MB > social MC
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market failure
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private market fails to produce efficient level of output
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fundamental cause of market failure
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incomplete/difficulty enforcing property rights
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if property rights are clear and enforceable
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no external cost or benefit exists, no externality associated with the market
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in the short run, at least ____ input(s) is/are fixed
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one
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fixed inputs have costs that
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do not vary with quantity of output produced in short run
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variable inputs have costs that
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vary with quantity of output produced in short run
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in the short run, total cost of production =
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total fixed + total variable costs
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in the long run, ____ costs of production are variable
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all
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in the long run, total cost of production =
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only total long run variable cost
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explicit costs involve
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spending money
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implicit costs are
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nonmonetary opportunity costs (firm owner's time, financial capital, economic depreciation)
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marginal product
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change in output generated by use of additional unit of variable input
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effect of specialization and division of labor
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increase marginal product at lower levels of output
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effect of fixed input acting as constraint on production
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diminishing marginal product at higher levels of output
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at low levels of output and of variable input used, marginal product
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rises
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at higher levels of output and of variable input used, marginal product
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fall
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MC formula
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(change in total cost) / (change in output) =
(change in total cost) / (marginal product)
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increase marginal product means
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each additional unit of variable input is more productive --> becomes less expensive to produce one unit of output
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decrease marginal product means
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each additional unit of variable input is less productive --> becomes more expensive to produce one unit of output
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marginal product of labor and marginal cost of output have what kind of relationship?
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inverse
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Average Total Cost (ATC)
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total cost per unit of output
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at output levels where MC < ATC, ATC is
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falling
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at output levels where MC > ATC, ATC is
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rising
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ATC crosses MC at
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minimum of ATC
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Average Variable Cost (AVC)
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total variable cost per unit of output
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at output levels where MC > AVC, AVC is
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rising
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at output levels where MC < AVC, AVC is
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falling
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AVC crosses MC at
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minimum of AVC
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Average Fixed Cost (AFC)
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total fixed cost per unit of output
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AFC continually ____ as output ___
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declines, increases
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economies of scale
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firm's long run avg cost falls as output increases
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constant returns to scale
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firm's long run avg cost remains unchanged as output increases
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minimum efficient scale of firm
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quantity of output at which all economies of scale are exhausted --> constant return to scale begins
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diseconomies of scale
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firm's long run avg cost rises as output increases
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diseconomies of scale begin when
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a firm grows so large that it becomes difficult and costly to coordinate its operation
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innovation allows entrepreneurs in competitive market to
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earn profit in the short run
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in the long run, competition
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forces price to fall --> revenue just covers costs of production
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firms in perfectly competitive markets are considered
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price takers
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firms in perfectly competitive markets are
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unable to influence market price
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profit =
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total revenue - total cost
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total revenue (TR)
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quantity sold X market price per unit
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average revenue (AR)
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(TR)/(quantity of output) = (Q X P) / Q = P
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marginal revenue (MR)
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change in TR generated by sale of one unit of output = (change TR) / (change Q)
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perfectly competitive firm
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P = AR = MR
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horizontal line at market price represents
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MR, demand faced by firm, price, AVR
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MR - MC =
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amount of profit earned by producing and selling last unit of output
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if MR > MC
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increase output
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if MR < MC
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decrease output
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MR = MC
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max profit
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profit maximizing level of output
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where difference between TR and TC is greatest
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profit =
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(P - ATC) * Q
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shut down
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firm still pays fixed costs, but saves variable costs of production
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shut down if
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price is less than avg variable cost
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network externality
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usefulness of product increases as more consumers use the product
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natural monopoly
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when economies of scale mean that one firm can supply the entire market at lower total avg cost than can 2 or more firms
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natural monopolies prevalent in industries that involve
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large fixed costs, small variable costs, small MC of production
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market power
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ability of firm to charge price > MC
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ECON 1200: EXAM 1