Econ 101, Second Midterm Material
Market Demand is derived by
horizontally summing individual
(Red line is market demand)
Market demand is more elastic than
individual demand curves.
Consumer 's Surplus is the difference between what a consumer is willing to pay, and what the
consumer has to pay; essentially, it is a benefit to the consumer. Calculating consumer surplus depends
on the type of good;
1. Discrete Good:
P = $5
Q = 4 units
CS = (9-5)+(7-5)+(6-5) = $7
i.e. the consumer saves $7. He is willing to pay more than that ($9) but doesn't need to. Consumer
surplus can't be negative. General formula for consumer surplus in a discrete good case:
CS = (WTP1 – P1)+(WTP2-P1)+...
2. Continuous Good:
ex. P = 32 – 4Q, P = 8
Solved for Q, Q = 6 (in diagram, 2)
Choke price : Q = 0
Solved for P, P = 32 (in diagram, 1.50)
CS = (1/2) bh
CS = (1/2) (32 – 8) (6)
CS = $72 Application of Consumer's Surplus:
>> The Disney Land Dilemma:
Consider an amusement park. The management of the park is trying to choose a price strategy. There
are three options, but Disneyland chose #3 because it maximizes revenue.
1. charge P* per ride.
2. charge P* per ride and an admission fee.
3. charge P* only an admission fee.
Price per ride vs Quantity of rides; demand curve = demand for rides.
1. charge P* per ride, consumer takes Q* rides.
Revenue = P*Q* = 1
2. charge T* as an admission fee, T* = 2.
Revenue = P*Q* + T* = 1 + 2
3. charge 0 per ride, consumer takes Q'' rides.
Charge T'' as an admission fee.
Revenue = T'' = 1 + 2 + 3
>> Tag – a – bag:
Policy issue: the amount of garbage being dumped into landfills. The City of Edmonton handles
garbage by charging each household a flat rate, meaning you pay the same amount of money if you put
out one bag of trash or seven. The incentive here is to create a program where people pay for each bag
removed so that the overall amount of garbage decreases. Tag-a-bag was implemented.
Financial Environment of Business
The Legal Organization of a Firm
1. Sole Proprietorship: Business is owned by a single person.
1. + Easy to form, easy to dissolve.
2. +All decision making power resides with the sole owner.
3. + Only taxed once; business profits are part of the owner's income, therefore he/she only
faces income taxes.
4. - Owner has unlimited liability, so creditors have access to your personal assets; they could
seize not only your business, but your home as well. You could lose everything.
2. Partnership: Business is owned by two or more people.
1. + Easy to form.
2. + Only taxed once.
3. + Spreads risk to other people (If the company goes down, everyone goes down together)
4. +Allows specialization. For example, a law firm with lawyers that deal with criminal law,
divorce law, personal injury law, etc.All in the same business.
5. - Each partner has unlimited liability.
3. Corporation:Alegal entity that may conduct business in its own name, just like an individual.
1. + Each share holder has limited liability.
2. + Corporations are well positioned to raise money.
3. - Corporate profits are taxed twice. (Initially taxed, then profits that go to shareholders are
subject to income tax)
4. - Principle agent problem; shareholders want to maximize profits, managers want to
maximize their happiness. These two objectives are not always consistent. >> Methods of Corporate Financing
• Bonds (Debt Financing):Abond is a legal claim against the corporation. It represents debt. The
return to a bond is the interest rate which must be paid whether the corporation makes profits or
not. Bondholders are not owners of the corporation!! They are creditors. In general, they will
have no say in the corporation's operations (unless the corporation is having trouble paying
back the loans). Bonds usually have a maturity date at which time the bondholders are repaid
the face value of the bond.
• Stocks (Equity Financing):Astock, also called a share, represents ownership in the corporation.
All corporations, even private companies, must issue stocks. Stockholders have a right to a
portion of the company's profits, called the dividend. However, unlike the bond market, they are
not assured a fixed rate of return on their stocks. Holders of the common stock elect the
company's board of directors and thus have some say in the company's operations. Holders of
the preferred stock do not have a vote but get preferential treatment in the payment of
The Market for Stocks and Bonds
1. The Primary Market: when a company issues new stocks or new bonds, these stocks and bonds are
bought and solid in the primary market.
2. The Secondary Market: a secondary market is a market in which existing stocks and bonds are
bought and sold. The corporation doesn't make any money in this market.
How to Read Stock Market Exchange:
Company Volume High Low Close Change
Nortel7pf 1.54 3.20 2.86 3.00 -0.29
Northgate 1435 1.54 1.40 1.40 -0.11
“What Influences the Demand for a Stock?”
1. Past performance in regards to earnings 9. Past record with dividends
2. Current earnings 10. How often management changes
3. Perceived future earnings 11. Competitors
4. The elasticity of the stock 12. Government policy
5. Current events (for example, a recession) 13. Stock availability
6. Price of the share 14. Where the company is invested
7. Corporation’s assets 15. Creditors
8. Price trends (for example, a bull market; 16. Ethics
an upward trend in stock prices or, a bear market; 17. The latest rations on corporate and
a downward trend in stock prices) government bonds
>> Production Theory:
Technology: the state of society's knowledge about the industrial and agricultural arts.
Outputs: the products that result from production (Quantity, Q)
Inputs: facts that are used to produce outputs. For ex. Labour (human capital) returns labour,
land (natural resources, natural capital) returns rentsLA, capital (buildings, equipment, physical
capital) returns rentsK, entrepreneurship (contribution of the owners)
Profits = revenue – costs
Profits = normal profit + above normal profits (neoclassicist believes entrepreneur receives all profits,
marxist believes the workers should receive above normal profits)
Costs = wages, rentsLA, rentsK Classifying Inputs
• Fixed Input: quantity of the input cannot be changed within the time period.
• Variable Input: quantity of the input can be changed within the time period.
• Short Run: time period in which at least one input is fixed (cannot be altered).
• Long Run: time period in which all inputs are variable.
Reduce Reduce Change Move to Fiji
Raw Labour Machinery
- Total Product: the total amount produced during some time period (aka output, Q)
AP of labour = Q/L
AP of capital = Q/K
- Marginal Product: the change in total product resulting from an incremental change in the use of one
input holding the quantities of all other inputs constant.
MP of labour = change in Q/change in L
L Q MP
0 0 ---
1 43 43
2 160 117
3 351 191
4 600 249
5 875 275
The Law of Diminishing Marginal Returns
“As more of a variable input is added to the production process, holding the quantities of all other
inputs constant, output increases but eventually at a dim