Economics Chapters 5-8 Review (Micro)
Test #2- December 5
Chapter 5: What Gives When Prices Don’t? (Government Choices,
Markets Efficacy, and Equity)
-When price is fixed below market-clearing, shortages develop (quantity demanded
greater than quantity supplied) and consumers are frustrated. Quantity sold =
quantity supplied only.
-When price is fixed above market-clearing, surpluses develop (quantity supplied
greater than quantity demanded) and businesses are frustrated. Quantity sold =
quantity demanded only
Fixed Prices = No coordinated Prices- The only way shortages or surpluses
disappear is by quantities adjusting to whichever is less. With fixed prices, either the
consumer or business is frustrated.
Rent Controls: Example of price ceiling, maximum price set by government,
making it illegal to charge higher price.
“Robin Hood Principal”: To take from the rich, and give to the poor.
-Housing shortages, an unintended consequence of rent controls, give landlords the
upper hand in dealings with tenants.
-A contributing factor to the shortage of housing may be that landlord’s benefits no
longer exceed opportunity costs.
-Remaining tenants may not see the incentive of keeping the rented space in good
condition, and may start collecting “key money”.
-Unintended consequence of rent controls is subsidizing well-off tenants willing and
able to pay market-clearing rent.
-Alternative policies to help the homeless are government subsides, to help the poor
pay rent, and government-supplied housing. But all polices have opportunity costs to
-Living Wage: 10$ per hour, enough to allow an individual in a Canadian City to live
above the poverty line. -Minimum Wage Laws: example of a price floor, minimum price set by
government, making it illegal to pay lover price.
-When governments set minimum wages above market-clearing wage, quantity of
labor supplied by households, will be greater than quantity of labor demanded
businesses, creating unemployment.
-Quantity of unemployment creating is increased minimum wage depends on the
businesses elasticity of business demand for unskilled labor.
-Alternative polices to help working poor are, training programs and wage
supplements. But all policies have opportunity costs to consider.
-To say that well functioning markets produce products/services we value most means
outputs go to the most willing and able to pay. Efficient market outcome may not be
fair or equitable.
-Efficient market outcome: coordinates smart choices of business’s and
consumers so outputs produced at lowest cost (price just covers all opportunity cost
of production) and consumers buy products/services providing most band per buck
(marginal benefit greater than price).
-Consumers who do not buy at market-clearing prices are unwilling because marginal
benefit is less than price. Even though they can afford to buy, or are unable to afford to
buy even though they are willing and marginal benefit is greater than price.
-In the public Canadian health care system, everyone has relatively equal access to
health care services. Prices paid by consumers (zero) and governments fix supplies.
Resulting in shortages and inefficiency’s because quantity demanded exceeds quantity
-In the private U.S health care system, anyone willing and able to pay has access to
health care services. Prices are set efficiently in markets, in that prices adjust to match
quantities demanded and supplied. Those unable to pay do not receive health care
services, resulting in inequity.
-The simplified comparison of health care in Canada and the U.S leaves out many
details to highlight the trade-off between efficiency and equity.
Positive statements: about what is; can be evaluated as true or false by checking
Normative statements: about what you believe should be; involve value
judgments. -Normative statements often use the word “should” and cannot be evaluated as true or
false by checking the facts.
-Once you pick a political position on social goal to support, based on your values,
economic thinking helps identify the smartest choice of action to efficiently achieve
benefits against opportunity cost.
Chapter 6: Finding the Bottom Line (Opportunity costs, economic profits
and losses, and the Miracle of Markets)
Accounting Profits = Revenues – Obvious costs (including deprecation)
Depreciation: Tax rule for spreading cost over lifetime of long-lasting equipment.
-Deprecation also means decrease in value because of wears and tears and because
equipment becomes obsolete.
Obvious costs: Costs a business pays directly
Accounting profit: Revenues minus obvious costs (including deprecation).
Implicit Costs: Hidden opportunity costs of what business owners could earn
elsewhere with time and money invested
-Wahid’s hidden opportunity cost (implicit cost) of investing his own 30’000 in his risky
business is 20 percent expected return, on $6000—Sum of guaranteed bank return of 5
percent plus risk compensation of 15%.
Normal Profits: Compensation for business owner’s time and money, sum of
hidden opportunity costs (implicit costs), what business owner must earn to do as
well as best alternative use of time and money.
Economic Profits: Revenues minus all opportunity costs (obvious costs plus hidden
Economic Profits = Revenues – All opportunity costs
= Revenues – (Obvious Costs + Hidden Opportunity costs)
Economic Profits = Revenues – (Obvious Costs + Normal Profits)
= Revenues – Obvious costs + Implicit costs Economic losses: Negative economic profits
-If revenues are less than all opportunity costs, business owner has not made a smart
decision. Would be better off in alternative uses of time and money. With economic
losses, business owner not even earning normal profits.
-Rule for smart business decisions: choose only when economic profits are positive
-When businesses focus on bottom line—pursuing economic profits—unintended
consequence is markets produce what consumers want.
-Economic losses are red lights, signaling not-smart business decisions—get off that
Breakeven Point: Business just earning normal profits (no economic profit, no
-Economic profits are green light signaling smart business decisions—get on that
Market Equilibrium: quantity demanded = quantity supplied. Economic profits are
zero and there is no tendency for change
-Changes in economic profits trigger changes in supply, changing price and bringing
demand and supply into balance. On the supply side economic profit is the