Exam Review Sheet
Production Possibilities Frontier (PPF): It shows the best an economy can do if it uses all its resources efficiently,
given the current technology.
Opportunity Cost: What must be given up to obtain some item.
Comparative Advantage: Somebody who can produce an item at a lower opportunity cost than somebody else is
said to have a comparative advantage.
Absolute Advantage: A producer that requires a smaller amount of inputs to produce a good is said to have an
Elasticity: Is the measure of how much buyers and sellers respond to changes in market conditions. It is also the
response of Qs or Qd in relation to price.
Price elasticity of demand: A measure of how much the quantity demanded of a good responds to a change in the
price of that good. It is the percent change in Qd given a certain percent change in Price.
*Price elasticity of demand (Ep) is calculated as --- EP = % change in Qd
% change in P
Coefficient of elasticity: The result of the above calculation.
Inelastic demand: This is when quantity demanded does not respond strongly to price changes. When EP is less
than 1, this is inelastic demand. The demand curve in this scenario is steep.
Elastic demand: This is when quantity demanded responds strongly to changes in price. Ep is greater than 1, and
the demand curve is fairly flat.
Perfectly Inelastic demand: Quantity demanded does not respond to price changes at all. This is when EP is equal
to 0, and the demand curve is completely vertical.
Perfectly elastic demand: Quantity demand changes infinitely with any price. In this case, EP = infinity. The
demand curve in this case is horizontal.
Unit Elastic: This is when quantity demanded changes by the same percentage as the price. In this case, EP is equal
to 1. Demand curve is non-linear in this case.
• • The midpoint formula is:
(Q 2 Q )1/ ([Q 2 Q ]1/ 2)
Ep = ____________________
(P 2 P 1 / ([P2+ P 1 / 2)
Generalities about elasticity:
1. Goods that are necessities tend to have inelastic demand.
2. Goods that are luxuries tend to have elastic demand.
3. Goods that have close substitutes tend to have elastic demand.
4. Goods tend to have more elastic demand over longer time horizons
Total Revenue: Total revenue is Price x Quantity Traded.
A company should INCREASE the price of a product if that product has an INELASTIC demand.
• TR will increase if Price Increase and if demand is inelastic.
A company should DECREASE the price of the product if it has an ELASTIC demand.
• TR will decrease if price increases and demand is elastic.
When a product is unit elastic, it should not either decrease or increase price because the change in price will be
offset by the change in quantity demanded, resulting in the same total revenue.
Price Control: Enacted when policy makers believe the market price is unfair to buyers or sellers. Government will
freeze prices at a certain level if it is better for society.
Price Ceiling: A legal MAXIMUM on the price at which a good can be sold. The price ceiling is not binding if ABOVE
the equilibrium price and is binding if set BELOW the equilibrium price, resulting in a shortage. Ex; Rent Control.
Price Ceilings can lead to…
1. Inefficient allocation to consumers
a. People who want the good badly may not get it while those who care less do
2. Wasted Resources
a. You spend a lot of time trying to find an apartment.
3. Inefficiently low quality
a. No incentive for landlords to keep up apartments if they have to rent them
Black market: Consumers willing to pay more than the price ceiling illegally to be able to purchase a good. Ex;
paying $500 to landlord “under the table” per month for rent in order to keep apartment. Price Floors: A price floor is a legal MINIMUM on the price at which a good can be sold. The price floor is not
binding if set below the equilibrium price. The price floor is binding if set above the equilibrium price, leading to a
surplus. Ex: Minimum wage
Price floors can lead to…
1. Surplus Production: Producers will want to sell more at a higher price
2. Inefficient allocation of sales: Those willing to sell the good at a lower price aren’t always necessarily able
to get it.
3. Wasted resources: Spending a lot of time looking for work
4. Inefficiently high quality: Adding fancy packaging to a good for a higher price, where consumers are
willing to pay less for lower quality merchandise.
5. Illegal activities: “I’ll work under the table for under minimum wage if you hire me”
Quota: Quantity control. The upper limit on the quantity of a good that can be sold. Ex; the amount of fish you can
catch and sell.
Taxes: Governments levy taxes to raise revenue for public projects.
Tax Incidence: The distribution of a tax burden.
Tax on consumers: Government puts a tax on a product, price will go up, demand will go down.
Taxes on consumers and taxes on suppliers are equivalent – the end result doesn’t matter on whom the tax is
Taxes reduce the quantity traded, increase the price consumers pay and lower the price suppliers receive.
The side of the market which is more inelastic (steeper curve) bears a larger burden of the tax.
• Less responsive to change
• Can’t adjust to compensate to any great extent
• You get stuck with a larger share of the tax
The greater the elasticity’s of demand and supply:
• The larger the decline in equilibrium quantity
• The greater the deadweight loss of a tax.
• Subsidies: Payments given to producers in order to increase market output or reduce price paid by
consumers. The opposite of tax levies. Subsidies shift supply curve to the right. Consumers gain by paying
a lower price. Chapter 11
Excludability: People can be prevented from using the good or service.
Rivalry: One person’s use of the good diminishes the ability of another person to use it.
Goods in 4 categories:
1. Private Goods: Both excludable and rival. For ex; choclolate bar
2. Public Goods: Neither excludable or rival. For ex; looking up to the sky.
3. Common Resources: These are rival but not excludable. Ex; fish in the ocean
4. Natural Monopoly Goods: Excludable but not rival. Ex; Cable TV
Free rider: A person who receives the benefit of a good but avoids paying for it.
National Defense: We all benefit from it, but one persons access to national defense doesn’t the protection of
Cost-Benefit analysis: In order to decide whether to provide a public good, the total benefits of all those who use
the good must be compared to the costs of providing and maintaining the public good.
Tragedy of Commons: A parable that illustrates why common resources get used more than is desirable from the
standpoint of society as a whole.
Competitive Market: A market with many buyers and sellers trading identical products so that each buyer and
seller is a price taker.
Average Revenue = Marginal Revenue = Price
Marginal Revenue (MR): Change in Total Revenue / Change in quantity
Marginal Cost (MC): Change in Total Cost/ Change in Quantity
For profit maximization:
1. If Marginal Revenue (MR) is > Marginal Cost (MC), firm should INCREASE output.
2. If Marginal Revenue (MR) is < Marginal Cost (MC), firm should DECREASE output.
3. If Marginal Revenue (MR) is = Marginal Cost (MC), firm has MAXIMIZED profit.
A Firm should shut down in the SHORT RUN If:
1. When Price (P) is < Average Variable Costs (AVC)
A firm will exit a market in the LR if:
1. When Price (P) is < Average Total Costs (ATC)
A firm will enter a market in the LR if: 1. When Price (P) is > Average Total Costs (ATC)
Profit can be calculated as
Profit = (P-ATC)Q
A firm will be indifferent exiting or enter the market when:
1. When Price = Average Total Cost.
When the demand curve shifts, the profit of a firm in a competitive market increases.
Sunk Cost: A cost that has already been committed and cannot be recovered.
Monopoly: A firm that is a sole seller of a product that has no close substitutes.
There can be 3 types of monopolies:
1. Resource monopoly: A firm has sole access to a resource
2. Government created monopoly: The patent/copyright
3. Natural Monopoly: When a single firm can supply a product at lower cost than two.
Unlike a competitive market, the price of the product is not equal to the marginal revenue. In a monopoly, the
price is greater than the marginal revenue and marginal cost.
Similar to a competitive market, a monopoly maximizes profit when Marginal revenue = marginal cost
Because a monopoly charges a price above the marginal cost, some consumers do not buy the product. This
creates Deadweight loss.
Price Discrimination: The business prac