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Final

# Economics Final Exam Review.docx

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Wilfrid Laurier University

Economics

EC120

Peter Sinclair

Summer

Description

Economics Final Exam Review
Law of demand: other things equal, higher the price of a good, smaller the quantity demanded
Law of supply: other things equal, quantity supplied of good rises when price of good rises
Price elasticity of demand: measure of how much quantity demanded of a good responds to a change in price of
that good (% change of quantity demanded / % change of price - always positive)
Inelastic demand - price elasticity of demand < 1
Perfectly inelastic demand - price elasticity of demand = 0 (I)
Elastic demand - price elasticity of demand > 1
Perfectly elastic demand - price elasticity of demand = infinity (E)
Unit elastic demand - price elasticity of demand = 1
Price elasticity of demand and total revenue
Inelastic demand - price and total revenue move in same direction
Elastic demand - price and total revenue move in opposite directions
Unit elastic demand - total revenue remains constant when price changes
Price elasticity of demand and total expenditure
Inelastic demand - fall in price decreases total expenditure
Elastic demand - fall in price increases total expenditure
Unit elastic demand - fall in price has no effect on total expenditure
Income elasticity of demand (% change in quantity demanded / % change in income)
Normal goods - income elasticity of demand > 0
o 0 < income elasticity of demand < 1 - necessity
o Income elasticity of demand > 1 - luxury
Inferior goods - income elasticity of demand < 0
Cross-price elasticity of demand (% change in quantity demanded for good x / % change in price of good y)
Substitutes - cross-price elasticity of demand > 0
Complements - cross-price of elasticity of demand < 0
Price elasticity of supply (% change in quantity supplied / % change in price)
Inelastic supply - price elasticity of supply < 1
Perfectly inelastic supply - price elasticity of supply = 0 (I)
Elastic supply - price elasticity of supply > 1
Perfectly elastic supply - price elasticity of supply = infinity (E)
Unit elastic supply - price elasticity of supply = 1
Price ceiling: legal maximum on price at which a good can be sold
Price ceiling < actual price - binding constraint => shortage
Price floor: legal minimum on price at which a good can be sold
Price floor > actual price - binding constraint => surplus
Tax incidence
Tax burden falls more heavily on side of market that is less elastic (willingness to leave market when
conditions become unfavourable) Total value: maximum amount consumer places on all units of a good consumed
Marginal value: measures incremental value to consumer of additional unit and diminishes as more is consumed
Total variable cost: area below marginal cost curve
Law of one price: when a product that can be cheaply transported is internationally traded it will tend to have a
single world price
Tariff: tax designed to raise price of foreign goods
Quota: restriction on amount that can be imported
Explicit costs: require an outlay of money (paying wages to workers)
Implicit costs: do not require a cash outlay (opportunity cost of owner’s time)
Production function: shows relationship between quantities of inputs used and maximum quantity of output that
can be produced using these inputs
Total product: total amount of output that is produced during given time period of time
Average product: (of variable factor) total product / # of units variable factor used to produce it (usually labour)
Marginal product: change in total product resulting from use of one more (or less) unit of variable factor
Law of diminishing returns (diminishing marginal product): if increasing amounts of variable factor are applied
to given quantity of fixed factor eventually marginal product of variable factor declines
As workers added, each can specialize on one task and marginal product rises
If there is fixed amount of physical capital, eventually marginal product begins to decline
What curves look like
Average product curve and marginal product curve are derived from total product curve
When total product is rising at increasing rate (curving up) marginal product is positive and rising
When total product is rising at a decreasing rate (curving down) marginal product is positive and falling
When total product is falling marginal product is negative
If marginal product > average product then average product will rise (average product curve slopes
upward when marginal product is above it)
If marginal product < average product then average product will fall (average product curve slopes
downward when marginal product curve is below it)
Marginal product curve must intersect average product curve at its maximum point
Declining marginal product implies nothing about average product
Total cost: full cost of producing any given level of output (total fixed cost + total variable cost)
Average total cost: total cost / level of output (average fixed cost + average variable cost)
Marginal cost: change in total cost associated with change in level of output Short run: length of time over which some of firm’s factors of production are fixed
Average fixed cost curve declines steadily as output rises (spreading overhead over more units of
output)
Shape of marginal cost curve depends on marginal product of labour (one rises, other falls)
Height/level of marginal cost curve determined by wage rate (price of input)
Slope of total variable cost = height of marginal cost
Total cost curve looks like total variable cost curve shifted vertically upward by amount of total fixed
cost
Height of average total cost curve is vertical sum of average fixed cost and average variable cost
Average fixed cost is everywhere falling so difference between average variable cost and average total
cost gets smaller as output rises
Marginal cost curve intersects average variable cost curve at lowest point where its slope is 0 and at this
level slope of average fixed cost is negative so slope of average total cost is negative (minimum of
average total cost occurs at larger quantity then minimum of average variable cost)
Marginal cost curve also intersects average total cost curve at its lowest point where its slope = 0 and at
this level average fixed cost curve is still falling so slope of average total cost is zero it must be true that
average variable cost is rising at that output
Average variable cost is at its minimum when average product reaches its maximum
Marginal cost curve reaches minimum when marginal product curve reaches its maximum
Increase in price of fixed input shifts TFC,AFC,ATC curves upward and shifts ATC minimum to the
right (vice versa)
Increase in price of any variable input rotates TVC,TC curves upward and shifts AVC,ATC,MC curves
upward and minimum points of AVC,ATC,MC stay the same (vice versa)
Long run: length of time over which all of firm’s factors of production can be varied
Long-run average cost curve is boundary between cost levels that are attainable/unattainable
(above/below) even when use of all inputs vary
Decreasing LRAC implies increasing profit/unit and economies of scale/increasing returns to scale
(change in output is proportionally more than change in use of all inputs) (ex. greater specialization)
Constant LRAC implies constant profit/unit and constant returns to scale (slope = 0)
Increasing LRAC implies decreasing profit/unit and diseconomies of scale/decreasing returns to scale
(change in output proportionally less than change in use of all inputs) (ex. difficulties in managing,
controlling enterprise as its size increases)
Any output level that can be produced at lowest LRAC characterized as efficient scale of output
If there is a range over which firm experiences constant returns to scale, if over that range LRAC is at its
minimum there are many output levels satisfying efficient scale where the smallest of these is called
minimum efficient scale of output
“Returns to scale” vs. “Diminishing marginal product”
“returns to scale” relates to change in output that results from changing all i

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