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Midterm #1

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Hannah Holmes

Test1: • Market economy: allocates resources through the decentralized decisions of firms and households • Command or centrally planned economy: all production and distribution decisions are made by a central authority, like a government • Opportunity cost: what you have to give up to get something. o Explicit and implicit costs • Market failure can be influenced by market power: the ability of a single person or firm to unduly influence market prices • Positive statements: describe world as is (descriptive analysis) • Normative statements: describe how world should be (prescriptive analysis) • PPF = production possibilities frontier • Comparative advantage: can produce at lower opportunity cost than someone else • Absolute advantage: can produce a good using fewer inputs (e.g. less time) • Productivity = quantity produced / number of inputs used • Elasticity of demand: % change in Qd / % change in price. Drop –ve sign • Midpoint formula: Ep = (Q –2Q ) 1 ([Q +2Q ] 1 2) ÷ (P – 2 ) 1 ([P +2P ] 1 2) o Inelastic: E<1 (% change Q < % change P), Elastic: E>1 o Perfectly inelastic E=0, perfectly elastic E=infinity o Necessities inelastic. Luxuries, close substitutes, long time horizon elastic • Downwards demand curve: top left elastic, midpoint unit elastic, bottom right inelastic • Total revenue = price x quantity o TR will increase if P increases, if demand is inelastic. o TR will decrease if P increases, if demand is elastic. o TR max when price elasticity = 1 • Income elasticity = % change in Q / % change in income. Sign matters. d o EI> 0, then normal good. (increase Q if increase income). o EI< 0, then inferior good. o EIbetween 1 and -1, good is income inelastic o EI>1 or E I -1, good is income elastic o necessities income inelastic, luxuries income elastic • Cross-price elasticity of demand, Eab % change Qd of ‘a’ / % change P of ‘b’ o E>0, substitutes. E<0, complements • Elasticity of supply: always +ve. o Es between 0 and 1, inelastic. Es>1 elastic. rest, same as Ed • Consumer surplus: buyer’s willingness to pay, minus amt actually pays for it • Producer surplus: amt seller is paid for good, minus cost • Allocation efficient if maximizes total surplus (consumer + producer) • Pigovian tax = tax levied to correct negative externality of market (usu. by gov) • Coase theorem: if private parties can bargain without cost over the allocation of resources, they can solve the externalities problem on their own. Sometimes, the costs of bargaining (called transaction costs) can be so high that private agreements aren’t possible Test2: • Price ceiling only binding if below equilibrium  shortage • Price floor online binding if above equilibrium  surplus (e.g. unemployment) • Quota: limiting Q. Quota rent = difference in Pd and Ps in quota. • Tax incidence = distribution of a tax burden. (consumers vs. producers). o The side of the market which is more inelastic (steeper curve) bears a larger burden of the tax. • The greater the elasticities of demand and supply, the larger the decline in equilibrium quantity, and the greater the deadweight loss of a tax • Economic profit = total revenue – total cost (explicit+implicit) • Accounting profit = total revenue – total explicit costs • marginal product = change in total output / change in # input. quantity / labour o Total production maximized when marginal product = 0 (crosses x-axis) o Average product intersects marginal product at max AP o When marginal product is max, marginal cost is min. • Marginal cost = cost per quantity o Marginal cost intersects AVC and ATC and min AVC and min ATC. o Min ATC is the point of efficient scale. • Economies of scale, EOS: long-run average total cost falls as Q increases. o Also called increasing returns to scale (IRS) or scale economies • Diseconomies of scale, DOS: long-run average total cost rises as Q increases. o Also called decreasing returns to scale (DRS) • Constant returns to
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