Review Sheet for Midterm Exam 2 - Principles of Microeconomics | ECON 101, Exams of Microeconomics

Download Review Sheet for Midterm Exam 2 - Principles of Microeconomics | ECON 101 and more Exams Microeconomics in PDF only on Docsity! 1 Review Topics for Midterm 2 Econ 101 - Fall 2009 Chapter 6: p.111 10.2.09 – 10.9.09 Budget Constraint: The limits imposed on household choices by income, wealth, and product prices. Opportunity Set: The set of options that is defined and limited by a budget constraint. Equations: I(ncome)=(Px*Qx)+(Py*Qy); Budget Line (BL): Y=(I/Py)-[(Px/Py)*X]; Slope=(-Px/Py); Y-axis=I/Py; X- axis=I/Px; Fig. 6.1 & 6.2 (p114): (1) A budget constraint separates those combinations of goods and services that are available, given limited income, from those that aren’t. The available combinations make up the opportunity set. (2) When the price of a good decreases, the budget constraint swivels to the right, increasing the opportunities available and expanding choice. Likewise, if the price of a good increases, the budget constraint swivels to the left, decreasing the opportunities available and limiting choice. Finally, if the price of both goods or income rises or falls, the budget constraint will shift inward or outward. Total Utility: The total amount of satisfaction obtained from consumption of a good or service. Marginal Utility (MU): The additional satisfaction gained by the consumption or use of one more unit of a good or service. Law of Diminishing Marginal Utility: The more of any one good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good. Utility-Maximizing Rule: Equating the ratio of the MU of a good to its price for all good. When slope of budget constraint line is tangent with the indifference curve. Marginal Rate of Substitution: (MUx/MUy), or the ratio at which a household is willing to substitute X for Y. When MUx/MUy is equal to 4, for example, I would be willing to trade 4 units of Y for 1 additional unit of X. As more of X and less of Y are consumed, MUx/MUy decreases. As you consume more X and less Y, X becomes less valuable in terms of units of Y, or Y becomes more valuable in terms of units of X. Indifference Curve (IC): A set of points, each point representing a combination of goods X and Y, all of which yield the same total utility. Properties of Indifference Curves: (1) Negative slope; (2) Don’t intersect, unless representing different people; (3) Convex toward origin. Equations: MUx=(TU/Qx); MUy=(TU/Qy); Slope of IC=(-MUx/MUy); Utility-Maximizing Equilibrium=(1) (MUx/Px)=(MUy/Py) or (2) (Px/Py)=(MUx/MUy); 2 Fig. 6.3, 6A.3, & MU (p117;132): (1) When marginal utility equals 0, total utility stops rising. (2) Consumer Equilibrium: Consumers will choose the combination of X&Y that maximizes TU. Graphically, the consumer will move along the budget constraint until the highest possible indifference curve is reached. At that point, the budget constraint and the indifference curve are tangent. This point of tangency occurs at X* and Y* (point B). (1) Deriving Demand Curve; (2) Engel Curve Substitution Effect and Income Effect: Normal Good; (1) Px increase & (2) Px decrease. 5 Average Revenue (AR): Total Revenue / Total Quantity. Note: In a perfectly competitive market, P=AR=MR Equations: TR=PQ; MR=(TR/Q); AR=(TR/Q) Revenue Curves in Perfect Competition: Short Run: The period of time for which (1) The firm is operating under a fixed scale of production, and (2) firms can neither enter nor exit an industry. Long Run: That period of time for which there are no fixed factors of production: (1) Firms can increase or decrease the scale of operation, and (2) new firms can enter and existing firms can exit the industry. Fixed Cost (FC): Any cost that does not depend on the firms’ level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run. Variable Cost (VC): A cost that depends on the level of production chosen. Total Cost (TC): Total fixed costs plus total variable costs. Total Fixed Costs (TFC): The total of all costs that do not change with output even if output is zero. Average Fixed Cost (AFC): TFC divided by the number of units of output; a per-unit measure of fixed costs. Total Variable Costs (TVC): The total of all costs that vary with output in the short run. Average Variable Cost (AVC): TVC divided by the number of units of output. Average Total Cost (ATC): TC divided by the number of units of output. Application Q TFC TVC TC MC 0 50 0 50 X 1 50 10 60 10 2 50 18 68 8 Cost Curves: TC, TVC, TFC, AC, MC, AVC, AFC; s in FC & s in VC. Equations: TC=TFC+TVC; MC = (TC/Q). 6 Fig. 8.10 (p169): Profit-Maximizing Level of Output for a Perfectly Competitive Firm: If price is above marginal cost, as it is at 100 and 250 units of output, profits can be increased by raising output; each additional unit increases revenues by more than it costs to produce the additional output. Beyond Q*=300, however, added output will reduce profits. At 340 units of output, an additional unit of output costs more to produce than it will bring in revenue when sold on the market. Profit-maximizing output is thus Q*, the point at which P*=MC. Short-Run Equilibrium: Breaking Even: The situation in which a firm is earning exactly a normal rate of return, or when a firm is earning zero profits. Shut-Down Point: The lowest point on the AVC curve. When price falls below the minimum point on AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs. Short-Run Industry Supply Curve: The sum of the marginal cost curves (above AVC) of all the firms in an industry. 7 Fig. 9.1, 9.2, & 9.3 (p179, 181, 183): (1) A profit-maximizing perfectly competitive firm will produce up to the point where P*=MC. Profit is the difference between total revenue and total cost. At Q* = 300, total revenue is $5300 = $1,500, total cost is $4.20300 = $1,260, and profit = $1,500 - $1,260 = $240. (2) When price is sufficient to cover average variable cost, a firm suffering short-run losses will continue to operate instead of shutting down. Total revenue (P*Q*) covers total variable cost, leaving $90 to cover part of fixed costs and reduce losses to $135. (3) At prices below average variable cost, it pays a firm to shut down rather than continue operating. Thus, the short-run supply curve of a competitive firm is the part of its marginal cost curve that lies above its average variable cost curve. Long-Run Average Cost Curve (LRAC): Shows the different scales a firm can choose to operate on in the long-run. A given point on the LRAC gives us the average cost of producing the associated level of output Long-Run Competitive Equilibrium: When P = SRMC = SRAC = LRAC and economic profits are zero. Any price above P* means there are profits to be made & firms will expand & and new firms will enter the market. Any price below P* means firms are suffering losses & existing firms will exit the market. Economies of Scale: An increase in a firm’s scale of production leads to a lower cost per unit produced.