Honors Principles of Microeconomics - Final Exam Review Sheet | ECO 2023, Study notes of Microeconomics

Download Honors Principles of Microeconomics - Final Exam Review Sheet | ECO 2023 and more Study notes Microeconomics in PDF only on Docsity! Microeconomics Final Exam Overview (Calhoun) Chapter 1: The Economic Approach  Adam Smith wrote The Wrath of the Nations where he discussed the invisible hand  Economic way of thinking- how economists analyze human behavior, how they try to understand human choices. Based on 8 guidelines: o There will always be tradeoffs- opportunity costs  No such thing as free lunch- you are always giving up your time o Individuals choose purposefully- people are rational o Incentives matter o Individuals think on the margin o More info leads to better choices, but more info increases costs o Secondary effects o Valuation is subjective o Good theories should be able to predict behavior (for average individual not a “unique” individual)  Positive statement is fact and can be proven  Normative statements are based on opinions  Pitfalls to avoid in economic thinking o Violation of the ceteris paribus condition  “other things constant” o Good intentions do not always lead to good outcomes o Association is not causation o Fallacy of Composition  What is good for you is not necessarily good for the group Chapter 2: Tools of Economists  Voluntary trade creates value for both parties o Transaction costs reduce gains from trade o Middle mad increase gains from trade thus creating value  Property Rights o Private- allow the right of exclusive use, to protect and to transfer/sell property o Common- allows multiple people to claim ownership rights  Property rights are important because they create incentives to protect, conserve resources, and distribute them to people who value them  Production Possibility Curve (PPC) shows the maximum combinations of two goods that can be produced from a set of fixed resources, holding technology constant and assuming all resources are being used efficiently  PPC is bowed outward because of the law of increasing opportunity costs o If PPC is straight- there is constant tradeoff of opportunity costs o If PPC is inward- there is a decreasing opportunity cost  Factors that shift PPC outward o Increase in resources o Technological improvements o Improving legal systems in order to allow resources to be utilized most efficiently o More hard work (less leisure) o *Encouraging business investment (with tax cuts) will also tend to shift PPC outward over time  Specialization and Division of Labor o An individual that focuses on one specific task instead of a series of tasks can become better at his job which increases output which leads to an increase in profit  Law of Comparative Advantage- in order to maximize output, individuals (businesses, countries) should produce goods for which they have the low opportunity cost Chapter 3: Supply, Demand and the Market Process  Change in quantity demanded is a movement along the demand curve that can only be caused by a change in price  Change in demand is a shift of the entire curve which may be caused by anything other than a change in price of that particular good such as: 2  Increase in Supply, Decrease in Demand- Price decreases; Quantity is ambiguous  Decrease in Supply & Demand- Quantity decreases; Price is ambiguous  Confusing I know! Draw out the graphs in the space I left and it’ll be much clearer!  The Invisible Hand means that self-interested individuals will produces what is valued by society the most without the direction of a central authority. Basically the Government should stay the f out of our business which is what Adam Smith believed in- the drive for free markets! Chapter 7: Consumer Choice and Elasticity  Elasticity of demand tells us how much more or less the consumer will purchase as price falls or rises o Elastic- more of a change in amount purchased when price changes (bigger change in quantity demanded) o Inelastic- less of a change in amount purchased when price changes (smaller change in quantity demanded)  Formula for Price Elasticity of Demand  Price elasticity of demand = |percentage change in quantity | |Percentage change in price|  Elasticity of demand > 1, then it is elastic 5  Elasticity of demand<1, then it is inelastic  Primary determinants of the price elasticity of demand o Availability of substitutes (most important)  The more substitutes the more elastic the demand o Percentage of Income- if the price of the good is higher percentage of your income then your demand will be more elastic o Time- the more time available the more elastic the demand, you can shop around  How elasticity affects total revenue (TR) o Elastic (opposite)- Price goes up (down), TR comes down (up) o Inelastic (same)- Price goes up (down), TR goes up (down) Chapter 8: Costs and the Supply of Goods  Costs represent the desire of consumers not to sacrifice goods that could be produced if the same resources were employed elsewhere  Short run is defined as the period of time in which at least one input is fixed, the time period in which a firm cannot alter the size of its plant or add/remove equipment o The firm can alter variable resources though (labor and raw materials)  Long run is the time period in which a firm can alter the size of their plant (and everything else) and when firms can enter/exit the market *Thus all firm’s resources are variable in the long run 6 Short Run Cost Curve Graphically Represented  The ATC Curve is U-shaped because: o ATC is high at lower levels of production because AFC is high (quantity is low, so that means AFC is high) o ATC is high at larger levels of production because MC is high (diminishing marginal returns) 1. The MC curve is swoosh shaped because as you add more variable resource (labor) to the fixed resource (factory) there comes a point where the variable resource has reduced efficiency, law of diminishing returns. 1. In other words, marginal cost and marginal product move in opposite directions 2. Relationships between the ATC curve and the MC curve: 1. When MC < ATC  ATC will fall 2. When MC > ATC  ATC will rise 3. When MC = ATC  ATC is at its minimum 7  Place a lower limit on price and must be set above equilibrium price to be effective  Generates a surplus  Generates deadweight loss  Non-price factors again will determine who will get the good  Minimum wage  Taxes: o Statutory incidence relates to the law that designates which party is responsible for paying the tax o Actual incidence is the actual amount of the tax paid by both the consumer and the producer  Supply and demand elasticities determine how the actual tax burdens are shared o The more inelastic group bears the burden o Regardless of who bears the burden, tax will always increase the price paid by buyers, decrease the amount of money received by seller and decrease the quantity transacted 10  The Laffer Curve shows the relationship between tax rate and tax revenue. It implies that at high tax rates, an increase in the tax rate will actually lower tax revenue  A subsidy is a payment to the buyer or seller of a good or service, usually on a per unit basis o The more inelastic group benefits from a subsidy  The problem with taxes and subsidies is that it distorts incentives and creates secondary effects, which are sometimes undesirable. o To be effective they must be implemented properly Chapter 5: Difficult Cases For the Market and the Role of Government  There are four major factors that can undermine the invisible hand and reduce the efficiency of markets: o Lack of Competition- which restricts supply which would lower the quantity available to increase prices o Lack of Information- which can lead to poor decision making o Existence of Public Goods 11  A public good is non-rival and non-excludable  Non-rival- making the good available to one consumer does not reduce its availability to others  Radio Station  Non-excludable- people who do not pay for the good can still consume it  Wikipedia  Note: A public good is not necessarily provided by the government  Public goods are difficult to allocate efficiently in the market because it gives individuals the incentive to free rides (no pay for a good but still consume it), making it hard to generate funds to pay for it. This leads to the underproduction of public goods since companies will not produce it as much since people don’t pay for it o Presence of Externalities (Two Types)  Negative externality is a cost imposed on you although you are not directly involved, and you would like to see less of it. Goods with negative externalities are overproduced and underpriced! 12 Chapter 10: Price Searcher Market with Low Entry Barriers  The characteristics of a competitive price-searcher market with low entry barriers (monopolistic competition) are: o There are many sellers o Low entry barriers  Anybody can enter the market o They sell differentiated but similar products  Dove caters towards women; Irish Spring caters towards men, in the end they all sell soap  The firm will close if MR < AVC or TR < TVC  The firm will keep producing as long as MR > MC  Note: Since each firm produces a differentiated product, there is no market supply or demand curve. There is only a firm supply and demand curve!  In a competitive price searcher market the firm has some control over price, thus they can raise prices so that they are greater than their average variable cost. But as they raise prices the quantity demanded is reduced  Short-Run: o If profit exists new firms will enter and steal some profits, making the demand for your firms products decrease which will shift the demand curve left o If losses occur existing firms will have to leave because they cannot cover their average variable cost, thus the demand for your firm’s products will increase and your demand curve will shift right  Long-Run: o As firms enter and exit the industry, the firms demand curve shifts until zero economic profit exists  At zero profit, there is no more entry or exit  Zero Economic Profit  P = ATC  An entrepreneur is someone who makes decisions based upon uncertainty, discovery, and business judgment 15  Entrepreneurs play a vital role in economic progress by discovering new products and services that create wealth o Market forces provide incentives (and signals) for entrepreneurs to try new ideas  The difference between price-taker and price searcher markets: o Due to advertising expenses, price searcher products will be priced higher than prices taker products  Price Discrimination is the practice of selling the same good to two or more groups of people at different prices  The only firms that can price discriminate are the firms that o Have a downward-sloping demand curve o Can prevent customers from re-trading the product o Can separate their customers into at least two groups  Elastic  Inelastic  Firms price discriminate to increase profits.  Firms price discriminate by setting a relatively high price for those customers with inelastic demand and a relatively low price for those customers with elastic demand Chapter 11: Price Searcher Markets with High Entry Barriers  A monopoly is a market structure characterized by a single seller of a well-defined product for which there are no good substitutes and high barriers to entry  An entry barrier is something that prevents you from opening a business in a particular industry. Some entry barriers are: o Economies of Scale  When the fixed costs in an industry are large, bigger firms can generally achieve lower average total per unit costs than smaller ones o Government Licensing and Other Legal Barriers to Entry  Another firm may have a license or patent that precludes you from offering the same goods or services o Somebody else owns the vital resource such as oil or diamonds  Entry barriers are important for a monopoly because it creates market power 16  In a monopoly the firm will continue to produce as long as MR > MC  Monopolists are not guaranteed Short-Run or Long-Run profits because: o The demand curve could shift left o The cost curves could shift up  The characteristics of an oligopoly is interdependence among firms which leads to strategic behavior  An oligopoly firm is greatly concerned about what the other firms in the industry are doing thus each firm will base part of their decisions on what they think other firms are doing or will do  Remember:  A perfectly competitive firm is not concerned about any other firm  A monopolist doesn’t have another firm to consider  A monopolistically competitive firm is only somewhat concerned about what other firms are doing because they are selling a differentiated product  The price and output decision under an oligopoly is that: o Sometimes oligopolies will act like perfectly competitive firms (price takers) o Sometimes they will act as monopolists (price makers) o Many times they switch between the two  Oligopolies will try to collude to keep prices artificially high  If firms jointly agreed to keep production low that would generally be good for all firms, but the incentive to cheat would be so great that the agreement would not last long.  The defects of markets with high entry barriers (monopoly and oligopoly) are: o Output is higher o Price is higher o Some gains from trade are not realized o Variety is lower  Some of the ways to prevent industries with high entry barriers are: o Antitrust Policies  Policies/laws made to ensure competition is present 17