# [ECON 101] - Midterm Exam Guide - Ultimate 22 pages long Study Guide!

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6 Feb 2017
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U of M
ECON 101
MIDTERM EXAM
STUDY GUIDE
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ECON EXAM OCTOBER 13TH 2016
The Core Principles of Economics:
1) The Cost-Benefit Principle: Evaluate the full set of benefits and costs of any choice you
face, and only purse a choice if it yields benefits that are at least as large as the costs.
EX) Coffee shop sells for \$3, you should buy if the benefit to you is at least \$3, you
really like coffee and this coffee shop makes good coffee, so you’ll buy it. But your
friend who hates coffee gets no benefit so she won’t buy it. Both are responding to the
balance of benefits, minus costs.
2) The Opportunity Cost Principle: The true cost of something is the most valuable
alternative you must give up to get it. Your decisions should reflect this opportunity cost,
rather than just the out-of-pocket financial costs.
The OR WHAT
Costs of her choice costs of her next best alternative = opportunity cost
3) The Marginal Principle: Break “how many” decisions down into a series of smaller, or
marginal, decisions.
NOT how many workers should I hire but should I hire one more worker?
Evaluate whether the extra benefit from hiring one more worker exceeds the extra cost of
that extra worker
Marginal Benefit the extra benefit you get from one more worker
Marginal Cost extra cost of that worker
Only hire if benefit > cost
The Equi-Marginal Rule if something is worth doing, keep doing it until your
marginal benefits equal your marginal costs
4) The Interdependence Principle: To fully understand the consequences of your decisions,
you must take account of how decisions interact with each other, how your decisions
depend on the choices of other people in the market, how decisions in one market
depends on other markets, and how today’s decisions depend on past and future
decisions.
Economic Surplus the difference between your total benefits and total costs
Generated every time you make a good decision as either a buyer or a seller
EX) Sony offers a job at \$60,000 a year, but you love the music industry so much that
you would have accepted the job even if it paid \$35,000. Your new job yields you an
economic surplus of \$25,000. Perhaps by signing up some new bands, you are expected
to generate an extra \$100,000 per year in new revenue, generating a \$40,000 economic
surplus for them
Framing Effect small differences in how alternatives are described, or framed, can lead people
to make different choices
Sunk Costs when the time, effort, and other costs you put into the project cannot be reversed
ALWAYS IGNORE
Individual Demand Curve a graph that summarizes your buying plans which plots the
quantity that you plan to buy at each price
Holding other things constant ignoring the interdependence principle and focusing on
how our demand is affected by price
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ALWAYS downward sloping as price gets lower, the quantity demanded gets larger
o Diminishing Marginal Benefit the marginal benefit of each additional item is
smaller than the marginal benefit of the previous item
o Why the graph is downward sloping
Demand curves are also marginal benefit curves
o Price equals marginal benefits
o Graph illustrates the price at which you will buy each quantity of gas. If you keep
buying until price equals marginal benefit, then the same curve illustrates the
marginal benefit of each gallon of gas.
The first few items yield a high marginal benefit so you would buy even at a high price
but at a higher quantity, the marginal benefit is lower, and so you would only buy at a
low price
The Law of Demand the tendency for the quantity demanded to be higher when the price is
lower
The Rational Rule for Buyers buy more of an item if its marginal benefit is greater than (or
equal to) the price.
Maximizes economic surplus
Think at the margin, compare the extra benefit of one more item with the extra cost and
evaluate these costs and benefits relative to your next best alternative
Market Demand the buying decisions of all people taken as a whole
Add up individual demand to discover market demand
You may have one individual’s information but you need this information from all your
For each price, add up the total quantity demanded by your customers
Scale up the quantities demanded by the survey respondents so that they represent the
whole market
Plot the total quantity demanded by the market at each price
Downward sloping as well
Movement Along the Demand Curve a change in price which yields a change in the quantity
demanded
Demand curve is fixed
Demand curve doesn’t shift following a price change because that curve already
summarize how much an individual will change their quantity demanded as the price
changes
Shift in the Demand Curve changes in other factors such as your income or the price of other
goods may affect your willingness to buy goods at each and every price. When the demand curve
itself moves
A rightward shift is an increase in demand because at each and every price, the quantity
demanded I shigher
A leftward shift is a decrease in demand because the quantity demanded is lower at each
and every price
Six Factors Shifting the Demand Curve:
1) Income
2) Tastes
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