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ECO100Y5 Final: Final Exam Study Guide

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Lee Bailey

UTM -ECO100Y5- Final Exam Study Guide ECO100Y – Lecture 1 – Chapter 3: Demand, Supply, Price  Course Outline   Be sure to review it before coming to lecture  Textbook 15 t edition  Read assessed outcome as  it will prepare you how to study for t course o Be able to apply the concepts and techniques of micro and macro‐economic theory to analyze unfamiliar patterns Learning Objectives:  ‐ 1. List the factors that determine the quantity and quality of a good   o Determined by tastes, income, related prices, old price and size of population ‐ 3. Study Plan  o i.e. Chapter 3.1 – Demand : If you don’t know the answer use tebook and research o All about answering questions listed after the chapte Week 1  – Equilibrium  1) Buyers and Sellers a) Demand: b) Supply c) Shortages and surpluses euilibrate buyers and sellrs d) S tatics depend on sloes 2) Other Prices a. Labour Markets determine wages b. Capital markets determine interest rates c. Foreign exchange markets determine exchange rate s Dema nd = Buyers  o UE P(price) and Qd(quantity demand) = 12‐2p  If price goes up, demand goes down  This is called Diminishing marginal utility(DMU) Supply = Sellers    Increasing marginal cost – the more you do of something the more it costs  Math formula: S = 2P – 4 o Positive relation as it is +2 – P o If suppl curve goes up it is a positive reln  i.e. horizontalntercept is ‐4, vertical intercept is 2. 4 divided by 2  The number 2 on the diagram is the Reservation Price of sellers  EQBM: P=QD=QS(helps balance demand)  i.e. 12‐2p=2p‐4 o 16=4P o P=4 o QD=12‐2(4)=4 o QS=2(4)‐4=4   EQBM Mechanism which CAUSES Equilibrium  o Shortages if P<4  o Results in SURPLUSES if price is too high(P>4)   In an example, if this happens to sellers they get shut  out of the market for increasing the price, as they drop  the price there is an increase in demand causing the  price to go back to 4 which is the Equilibrium  Shortages and Surpluses equilibrate buyers and sellers   Refer back to the formula : QD(Quantity Demand) = 12‐2p  o The 12 is the shifter  o The (‐2) moves along   o SUPPOSE   Q1D = 16‐2P   QS = 2P‐4   At Po =4   D>S   Demand: 8> Supply: 4   Therefore, a short as price is above 4    If the supply curve is steeper, the price will go up by 5  STATICS depend on slope  WHEN DD SHIFTS…SLOPE OF SS IMPORTANT  WHEN SS SHIFTS FOCUS ON SLOPE   Elasticity =  shift of supply curve   Need : Determine the demand for product ; makes demand curve steep  o If you end up in the hospital with a broken arm, the likelihood is higher of paying   o The availability of substitutes and how good they are, therefore needs substitutes time        ECO100 – Lecture 2 – Elasticity     Chapter 4 I clicker questions (Could be on tests/exams)   When price of X fell from $10 to $8 the quantities demanded of Y decreased from 400 to 200.  These goods are:  o Substitutes in consumption  o Complements in consumption  o Substitutes in production – is the correct answer   o Complements in production   If total expenditures rise when the price rises, then the price elasticity of demand is  o Equal to zero  o Less than 1   o Equal to 1  o Greater than 1 – is the correct answer   o None of these    When John’s income rose from $8000 to $10000 quantities demanded increased from 200 to  400. This good is   o Inferior   o Substitute  o a necessity  o a luxury – is correct    Reminders  If your customers are price sensitive, feel free to decreases prices (E=PQ P<1 E increases; P decreases)*  If your customers are not price sensitive, feel free to increase prices (E=PQ P>1 E increases; P increases)*    Iclickers Round 2 of Chapter 4 from Textbook  1. Demand curves in Region A and Region B have the same slope but the demand curve in Region A  has a bigger horizontal intercept. This means demand in Region B is more elastic  a. True – is the correct answer  b. False  2. Supply curves in Region A and Region B both come through the origin but the supply curve in  Region B is flatter. This means supply in Region A is more elastic  a. True   b. False – is the correct answer  3. Supply curves in Quebec and Ontario have the same vertical intercept but the supply in Quebec  is more elastic  a. True  b. False – is the correct answer  4. Supply curves in Quebec and Ontario have the same slope but the supply curve in Quebec has a  bigger horizontal intercept. This means supply in Ontario is more elastic   a. True  b. False – is the correct answer         ECO100: Lecture 5 – Supply Curve Income effects: Optimal demand for good x depends positively on income M for the case of normal goods (Refer to Figure 6A-5 in textbook) Own-price effects: Optimal demand for good x depends negatively on its Px(demand curves slope downwards) unless the income effect dominates the substitution effect(Figure 6A-8 and Figure 6-3 in text)  If cost goes down, X goes up  If substitution effect dominates demand, income goes up  M=16, PX=4 PY=2 PX=1  Suppose the price of good falls by 75%  Bundle a(2,4) C(8,4)  C TAN Y/X=1/2= X+2Y=16  Plot points A(2,4) (b(4,2) c(8,4) o Cost = 8 U=8 o CBL 1X+2y = 8(horizontal intercept)  Put these points into a scenario when the person is buying good x,  Key Idea(U=XY) Restrictive Utility Function – C1 Examples i.e. potatoes were an inferior good, irish people were poor and use to eat these potatoes. The price of potatoes went up and there was a substitution effect. To this the irish peasants said the opportunity cost is higher, this makes us so poor. If something little went up by 10% the irish would consume more of those potatoes. This created a sloping demand  Main Idea -> higher pricer, more quantity , in order to be a giffin good, it has to be something inferior good that you would normally buy more of Labour Supply (Leisure Demand) 1. The budget line is affordability F=A + wH and H+Z = 24 2. A worker’s indifference curves embody preferences for leisure z and food f 3. Optimal labour suppliers set their mrs equal to the opportunity cost of leisure tangency 4. The labour supply curve embodies optimal choice 5. Statics(shifts): changes in non-labour income induce parallel shifts of the b-line that cause income effects 6. Statics(Notations): change in the wage induce relations of the b-line that lead to income and substitiution effects Iclicker questions 1. When the price of Good X increases, a maximizing consumer will purchase more Good Y if a. X is a normal good b. X and Y are complements c. X and Y are substitutes – the right answer d. X is an inferior good When the price of good X goes up, the line rotates. This is a cost-price effect. When the price of good X goes up, the person is gonna buy more of good Y and therefore buy substitutes as X gets more expensive 2. The demand curve for inferior good shifts left when income falls a. False – right answer b. True 3. Both goods must be normal when utility is U= XY a. False b. True – right answer 4. When the price of good Y increases the substitution effect says buy more Y if… a. Good Y is normal b. Good X is a substitute - right c. Good X is a complement d. Good Y is inferior e. Always less Y 5. A consumer purchases 4 units of Good X. When the price of Good Y falls and he purchase 6 units of Good X. We can conclude that Good X and Y are a. Substitutes b. Complements – as Y get cheaper, x buy more there it is correct We measure substitution effects vertically and income effects vertically* Labour Supply F=wH+A H+Z = 24 F = 24w+4-wZ is spending on food (dollars per day) H is the number of hours you work w is the wage  Suppose its $2/hr, a is the asset income measured in $/day  Spending cannot exceed income Z is the number of hours for leisure (12/day)  *If you were to graph this, the vertical intercept is 60;  *2 x 24 = A = 12  Tastes U=ZF o Diminishing marginal utility is high if you have a high consumption, as you consume more and more it gets low  If your mariginal utility was 13, that would imply your giving that up ; to maximize your utility set your marginal rate of substitution = to the budget line; this will give you a tangency condition that states  F= 2z  F=60-2z  Statics – an increase in non-labour income would cause your budget line to shift out and have an intercept of 8 ECO100 – Lecture 6 – Test review Iclicker questions 1. Utility is U=XY. Income is m = 4, px = 4, py = 2. Costco offers members a discounted px = 1, but charges a membership fee. What is the most you would pay to join Costco  ½ = x , 1 = y, HAIC: Fee = M – Cost b,  Ub = Uz.  U = xy , MRS(slope) = y/x,  z: y/x = 4/2  Y = zx  4x+2y = 4,  U(1/2x1) = ½  b: xy=1/2: ZY = X} y=1/2 x=1 Cost = $2 a. Less than $2 b. $2 – is the correct answer c. $3 d. $4 e. More than $4 2. Utility is U = x + y. The goods are perfect substitutes. Indifference curves are linear with mrs = 1. Income is m=6, px = 3, py = 2. What is the most you would pay to join a club selling good X at px = 1? Formulas: HAIC: Fee=M-Cost b Ub=Uz  I = xy  Mrs = ocost o 1 = 3/2 o X = 6/2 o Y = 6/3  Px:ocost 1/2 o Means youll be spending all your money on good x o Cost : x =3 o Px =1 A. Less than $2 B. $2 C. $3 = the answer D. $4 E. More than $4 3. Utility is U=x^2 + y^2. Good x is crack cocaine. Good y is food. Indifference curves are concave. Income is m=6, px = 6, py=3/ CrackCo offers members a discounted px=1, but charges a membership fee. What is the most you would pay to join Crackco? HAIC: Fee = M – Cost B Ub = Uz  To find point A: use HAIC formula o A = 2 o U = 36  Point B o Uz=4=UB o Px = 1; X=2 o M = 6 o Therefore the most you would be willing to be is $4 a) Less than $2 b) $2 c) $3 d) $4 e) More than $4 Gary Becker H  Wrote down models about how people behave  Econ professor at Harvard  Wrote down model of decision making(good x and good y) about how people behave  The number of kids is good x, good y is a composite good consisting of everything non- kid.  PxK+PyY=M o Ocost have to o U(K,Y) o Highest affordable difference curve touches the budget line(Ux) o Mrs will to o Py = cross price o More goods if good y is a complement o Good x if it’s a substitute Substitution effect opportunity cost is lower; give up good y to have good x Income effect – If income effect dominates substitution it affects good x in a bad way Key Formula:  2-Period Model o M1=50, M2= 60, r=20%(interest rate) o F2(spending on item) > M2(not allowed to exceed income)+(1+r)(M1-F1)[Return on savings] o F1+ F2/1+R = M1(Present discounted value of lifetime earnings) o M1+M2/1+r = 100(Present discounted value of income) Tips: Interest rate  If interest rates go up the budget line tips -> substitution AND income effect  the interest rate is the opportunity cost of consuming today  If spending goes down, savings go down  Higher interest rate results in more saving Income Effect  (Wealth goes up -> people perceive they are wealthy when price goes down)  If income effect dominates substitution effect, object moves to the right on the graph ECO100 – Lecture 7: Technology 1. Technology o Production functions  Q (output your firm produces) = f(K(capital), L(is labour)) 1. E.g. q=KL 2. TE= Technological efficiency = says q is the most you can produce 3. K/L/Q: Milk  If our production function is KxL ; you can produce 4 L of milk per hour with two cows and milk pits  Therefore, the production function lists fees able alternatives b. Returns to scale(Fig.8-1 in textbook) i. CRTS (Constants return to scale) 1. if 2xk ; 2xL ; Gives 2xq 2. i.e. if you wanted two cookies and got half 3. i.e. breaking bread is return to scales ii. IRTS (Increasing returns to scale) 1. if 2 x k; 2 x L = >2xq 2. q= KL ii. Cobb Dougles 1. Developed the formula: q=K^AL^b a. if a+b = 1(e.g. q=K^1/2L^1/2CRTS b. a+b <1 DRTS (Decreasing Returns to Scale) c. a+b >1; q=K^1L^1 ; IRTS c. Product curves (Fig. 7-1 in textbook)  TP^L = f (L, K), q=K^2L^2  K = 4; TPL = 16L^2  APL = 16L^2/L = 16L  MPL = 32L  Output per workers: AP^+-L (Average Product) = TR/L; MP^L (Marginal Product) = TR/L  The marginal product curve(MPL) is the slope of the Total Product curve(TPL) 1. APL = Average slope; MPL= slope of TPL 2. When the ray from the origin is tangent from the total; marginal and average are equal d. Diminishing Marginal product 2. Isoquants(Fig.8A-2 in textbook) a. Lines of equal products b. Come directly from the production function i. i.e. if your production function is q = KL ii. If you had more labour and capital, youd have an high isoquant iii. Slope isoquant 1. MRTS(Marginal rate of technical substitution) a. MPL/MPK(horizontal/vertical axis) b. How much K you can give up if you high more than 1 worker c. If symmetric; q=KL OR q=K^1/4 L^1/4 i. MRTS = K/L d. ISO Costs: i. Definition: line of equal quantity; iso cost is a line of equal costs ii. W is page of workers; r is the price of buying capital 1. W = 1; r = .25; c =4; 1L + .25K = 4 2. Slope = 4 = W/R 3. 16/4 ; c = 4 4. W/R = Opportunity cost a. The opportunity cost of hiring 4 workers is 4 units of capital iv. Cost Minimization(has four steps) 1. Running: A 1312 2. Hiring (K, L) 3. Price 4. ENTER  Decision 1 and 2 depend critically on industry structure  Every firm hires worker, which sets CAPITAL(K)  That decision is conditional on how much output you produce  As manager, your job is to sell coffee as efficiently(cheaply) as possible = COST MINIMIZATION o Looks like a curve on a point on a line in a graph  Looking for the lowest line that touches the curve  TAN = MRTS = W/R o Q = KL = k/L = 1/0.25 ; K = 4L  Sufficiency condition: your cost of labour and capital have to be enough to produce 16 units of output o If your production function is q = KL then that means KxL has to be 16. o Substitute tangency condition into sufficiency  KL = 16; 4L^2 = 16; L = 2, K = 8 ECO100: Lecture 8 5.1 ENTRY AND EXIST: PIE AND N 5.2 Industry Supply: P= mc Deriving the Industry Supply curve R = .25, w = 1, F = 4 Q= K^1/4L^1/4 D=80-10p MRTS = K/L OCOSTL= W/R = 4 OcostL= W/r = 4 TAN: K = 4L^2 = Q^4(L=1/2Q^2) =: Q^2+4 = AC: q+4/2 = MC = 2q Suff: KL = q^4 FIRMS P= MC  P = 2q  Q^3 = 1/2p  S = nq^5  N==?  MES: pie = 0, P = AC, n* o If P = 4, d = 80-10P, q = 40 o N=40/2= 20, s = 20X1/2P o S = 10P 5.3 Demand Shifts 1. MES(Slope), AC (Average cost) = MC (Marginal cost) 2. Po = MC, mc = 2q, Po =4 3. Qo, No= Qo/qo=20 4. q^s= 1/2p, S = 10p 5. P1: D1= So, P1 =8, Q1 = 80, n1 = no, q, q4=4 6. Pie1= R-c=32-(16+4)=12 Pie > O therefore number of entries(n) would go up Increase in n means P(price) goes down until pie is 0, P2 = 4, q2=2 7. S2, n2= 120/2 = 60, S2 = 30P, q^s=1/2P Therefore competitive industry would mean industry is in good use Example: Do = 80-10p D1 = 60-10p ICI(Increasing Cost Industry)  Happens because there is scarcity in input markets  n increases, w increases, AC increases, MC increases CCI (Constant Cost Industry)  N increases, AC and MC will remain constant DCI (Decreasing Cost Industry)  Shared n cost  AC decreases  MC decreases  Costs move in the opposite directions of ICI  The greater the number of firms, the higher the cost  C = q^2-nq+16: Do = 24-2p, D1=28-2p 1. AC=MC, MC= 2q=n, AC = q-n+16/q  Marginal cost is 2q – n, but we just found out q is 4, so marginal cost is 8-M  P=8-n because firms = marginal cost i. Q = 4n ii. Q= 24-2P iii. 4n – 24-2(8-n) iv. 2n = 8, no=4, Po = 4, Qo = 16  MCO – 2q-4 i. P=MC, q^s= ½+2 ii. S = nq^S iii. So = 2P+8 iv. S=2P+8 v. D= 28-2p  P1: S = D1  2P+8 = 28-2p  4P = 20  P1 = 5, q1= 1/2P+2 6. pie 1= __>O, MC decreases, MC decreases S R n increases Explain Price  P2=24, Pie2 ECO100: Lecture 9  4.2 Substitiution Effects and Output Effects  A firm with production function q‐K^1/4L^1/4 pays, w=1, r = .25 and F = 4. The firm is a price taker at   p =4  Illustrate SE and OE if w = 25   T = K = 4L   S = KL = q^4   4L^2 = q^4   L = 1/2q^2   K=2q^2   C = q^2 + 4   MC = 2q  BUNDLE A   P = 4   P = MC   q=2   L=2   K = 8  o W1= .25  o T: K=l  o S: BUNDLE C   L^2=Q^4   L=Q^2   K=Q^2   C=1/2q^2   MC = q   R= MC; q = 4; K = 16; L = 16  Bundle B   SE ; q = 2   S: KL = 16   T: L   K=4 L = 4   When capital becomes relatively expensive, you should use more labour because it becomes  cheap  o Leads to substitution effect to move to the right on the graph  o The output effect from b to c states to use more labour  o The output effect for capital going from b to c dominates the substitution effect     A Competitive Industry faces market demand Q = 100‐2P and consists of firms with total costs C = q^2‐ 5q+100. Next month the government will implements a per unit tax. After entry and exist occurs,  revenues from the tax can be calculated as R=1Xq   Calculate the value of t that will maximize the government’s tax revenue. How many  firms will exit the industry in response to this tax?   Provide the pair of diagrams  o Qo: AC = MC ; q = 10  o P = MC = 2q‐5 = 15  o P2 = 15 + t  o Q2 = 100‐2(15+t)  o = 70‐2t  o R = Tq  o R = 70t‐2t^2   Maximizing function   dR/dt = 70‐4T = o   T = 17.50   The marginal and supply cost shifts up; the supply curve rotates up in  response to losses   A) A Perfectly Competitive Industry faces demand Q = 14‐P and consists of many identical firms  each with costs C = q^2‐nq‐9   Provide a pair of fully labelled diagrams and supplementary calculations to asses the  impact  o Q=14‐P; C = q^2‐nq+9, T = 7  o MES:MC=AC; qo=3   Q = 3n   Q = 14‐P   P= 6 – n   3n = 8+n   No=4; Po=2, Qo = 12   MCo = 2q‐4   Q^5=1/2P divided by 2(Industry supply curve)   So = 2p+8 
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