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Economics Midterm 2 Review

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ECON 1131
Can Erbil

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Economics Midterm 2 Chapter 8: International Trade Why did the United States put a tax on the European Union for luxury goods? - The US didn’t want to hurt US consumers, but they wanted to tax European producers Imports – goods purchased from other countries Exports – goods produced domestically and sold to other countries Globalization – phenomenon of growing economic linkages among countries Ricardian Model of International Trade – analyzes international trade under the assumption that opportunity costs are constant Autarky – a condition when a country is not involved in any trade Countries will specialize in commodities in which they have the lowest opportunity cost - Ricardian model shows that trade makes both countries better off than they would be in autarky ComparativeAdvantage – if the opportunity cost of producing the good or service is lower for one country than it is for other countries, that country has the comparative advantage. Gains from trade are dependent on comparative advantage Trade liberates countries from self-sufficiency and makes more efficient markets. Relative prices – prices of one good in terms of another in international markets (no country must pay a price greater than its opportunity cost of obtaining the good in autarky) Pauper Labor Fallacy – when a country with high wages imports goods produced by workers who are paid low wages Sweatshop labor fallacy – trade must be bad for workers in poor exporting countries because they are paid very low wages by our standards *It is to the advantage of both countries if the poorer, lower-wage country exports goods in which it has a comparative advantage 3 sources of comparative advantage: 1. Differences in climate – tropical countries export tropical products, and some trade is driven by different seasons in countries 2. Differences in Factor Endowments – factors of production due to differences in history and geography 3. Differences in technology – knowledge gained through experience Hecksher-Ohlin Model – shows relationship between comparative advantage and factor availability in a country - Factor Abundance: how large a country’s supply of a factor is relative to its supply of other factors - Factor intensity: producers use different ratios of factors of production in the production of different goods (some used more than others) Acountry that has an abundant supply of a factor of production will have a comparative advantage in goods whose production is intensive in that factor. Domestic demand curve – Chapter 11: Inputs and Costs Firms produce goods and services for sale. Production function – the quantity of output depends on the quantity of input Fixed input – the quantity of this is fixed and cannot be varied (within a specific time period) Variable input – quantity can be varied any time In the long run, firms can adjust the quantity of any input, but in the short run, one input must be fixed. Total product curve – a curve that shows how the quantity of output depends on the quantity of the variable input (slope is not constant) Marginal product of labor – the additional quantity of output generated from using one more unit of labor Marginal product – the additional quantity of output produced by using one more unit of an input Change∈Quantityof Output Marginal Product = Chane∈Quantityof Input - The slope of the total product curve is equal to the marginal product of labor There are diminishing returns to an input when an increase in the quantity of input reduces that input’s marginal product. Fixed cost – a cost that doesn’t depend on the quantity of output produced (in short run) Variable cost – depends on the quantity of output Total cost = Fixed Cost + Variable Cost Change∈TotalCost Marginal Cost = Change∈Quantityof Output Marginal cost graphs DON’T start at the origin. As quantity goes up, marginal cost goes up and marginal benefit goes down. Objective of a firm: maximize total net benefit Net Benefit = Total Benefit – Cost To find the maximum net benefit, find where marginal cost and marginal benefit are equal. MarginalUtilityof A MarginalUtilityof B Optimal Consumption Rule: Priceof A = Priceof B The total product curve is increasing in a decreasing manner, and the slope is not constant because it flattens over time. (Each worker will generate less than the last worker – “too many cooks in the same kitchen” will push marginal utility downwards) You have to pay each worker the same, so even though their productivity is decreasing your cost is increasing. The total cost curve is increasing in and increasing manner (gets steeper with more output) The marginal cost curve is also upward sloping because there are diminishing returns to inputs TotalCost Average Cost = Quantityof Output (Gives a U-shaped total cost curve) ¿Cost Average Fixed Cost = Quantityof Output Average Variable Cost = VariableCost Quantityof Output Increasing output has two effects: Spreading Effect: the larger output, the greater the quantity of output over with fixed cost is spread (lowedAFC) Diminishing Returns Effect: larger output, greater amount of variable input required to produce additional units (higherAVC)  These effects are opposing against each other, and the diminishing returns effect dominates the spreading effect The bottom of theAverage Total Cost curve is the level of output at which the marginal cost curve crosses theATC curve from below. - This is the minimum cost output - When MC =ATC, this is the minimum average cost - At this point, ATC is neither rising nor falling The marginal cost curve begins increasing due to specialization, but eventually decreases. - It slopes downwards initially because a firm with few workers can’t reap the benefits of specialization of labor - Increasing specialization leads to lower marginal cost initially, but once specialization benefits are exhausted marginal cost increases *All inputs are variable in the long run (the firm chooses its fixed cost in the LR based on the level of output it expects to produce)!!! - There is a trade-off between higher fixed cost and lower variable cost for any given output level Long RunATC Curve – when fixed cost has been chosen to minimizeATC for each level of output The short runATC curve touches the long runATC curve at whichever quantity you’re producing at Returns to scale – if you increase the scale of production, cost will go down Chapter 12 – Perfect Competition Price-Taking Producer – their actions have no effect on the market price of the good they sell Price-taking consumer – have no effect on market price of the good they buy In a perfectly competitive market, all market participants are price takers. - In perfectly competitive industry, producers are price takers To be a perfectly competitive industry: 1. There must be many producers who don’t have too large of a market share 2. Consumers must regard the products of all producers as equivalent (standardized product) 3. Free entry and exit into the market Free Entry/Exit – when new producers can easily enter or exit an industry (adjusting to changing mark
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