Microeconomics Midterm

Income elasticity

can be positive or negative (normal or inferior good) also want to know that if other things equal, if a change in income will result in a more or less than proportionate change in demand

Semi-public goods

fisheries; "commons" - rival but non-excludable

If income is given, then it is...?

fixed

what is the focus of a command-and-control approach to reducing pollution?

government imposing quantitative limits on the amount of pollution firms are allowed to generate

Explain what we mean when we refer to externalities as "refuge of a scoundrel"

government intervention encourages rent-seeking

If consumer has maximized U, then...?

he/she has no reason to transfer expenditure from one to another. So MUs per $ must be equal when consumer is in equilibrium

What does the consumer exhaust?

his/her budget

What is the only way utility can change?

if quantities of x/y change

What dominates when it comes to revenue and P and Q?

if the demand is elastic, then a fall in price will raise revenue because the proportionate change in quantity is greater than that of price

Cross-price elasticity

measures the responsiveness in demand to changes in other good prices depends whether the goods are substitutes or complements

Can indifference curves cut?

nEVER

Elasticity and the importance of units

need for a "unit-free" measure I.e. measure that usesly only percentage changes

Inferior good

negative

Substitution is always...?

negative

Sin taxes

objective to lower consumption but if demand is inelastic then the main result is the tax becomes a good source of revenue and a less effective instrument of reducing "sin"

Example of a public good

over-the-air television broadcast of the National Basketball Association's finals hiking in a large park (no congestion) not surrounded by a fence

Society is always better off when the market is acting at....

point of the marginal benefit

Normal good

positive

Income can be both...?

positive (+ve) or negative (-ve)

What ways can price be decomposed?

price change on income (income effect) relative price effect (substitution effect)

Examples of command & control when it comes to externalities

price controls (ceilings/floors) cap and trade (hybrid)

Connection between cost of living and price-index

price index based on a given basket of goods only way to calculate "an average price" I.e. prices are "weighted" by their quantities in the bundle

Tragedy of the commons

problem of defining property rights

problems of supply of public goods

problem of free-riding therefore public goods are supplied by public sector

Consumer theory

provides framework for analyzing consumer behavior and demand connect diminishing marginal utility to the downward sloping demand curve and diminishing marginal benefits

Public goods

public safety; national defense - non-rival and non-excludable

If good is inferior and the negative income effect dominates

upward sloping demand curve --> demand increases as price rises aka Giffen good

private vs. public solution for externalities

usually externalities internalized when property rights are well defined (the fable of the bees; the Coase theorem)

Semi-private goods

utilities; cable TV - non-rival but excludable

How do we calculate the last $$ worth of expenditure?

utlity

Market failure

when perfect competition fails to yield optimal welfare

Elasticity: if P falls !5, what happens to Q?

will rise if it rises by more than 1% then we say demand is responsive or elastic. if it rises by less than 1%, we say that demand is inelastic if Q changes by less than 1%, it is unresponsive or inelastic

Example of how substitution effect always dominates

Fast food as an inferior good If income falls, other things equal, demand will rise. If income rises, demand will fall.

2 effects when Px falls

1. Raises "real income" of consumer (the purchasing power) 2. Makes Y relatively cheaper so the consumer will want to substitute Y for X

Example of a private good

Mail delivery Education in a private school (grades K-12) An apple

Elasticity

Measuring responsiveness of demand and supply to price changes

What might the demand for a product to become more elastic?

- more of a luxury - were a larger share in the consumer's budget - had more close substitutes

Why do many economists argue "real" measures of income (ex. $ measures adjusted for inflation) understate real income and therefore real economic growth?

- understate the effect of "new" goods - understate quality improvements - ignore effect of substitution and therefore overstate inflation

Taxes

Aim to make the marginal private cost equal to the marginal social cost

True or False: The more time the passes, the more inelastic the demand for a product becomes

False; the more time the passes, the more elastic the demand for a product becomes

Consumption externalities

Congestion Networking effects Education Neighborhood effects

Rationality

Consistent preferences I.e. they can rank bundles or "baskets" of goods

Examples of positive externality

Consumers who install solar panels benefit others Homeowners who tend to their yards benefit other homeowners and views --> neighborhood effects

cost benefit analysis

MSC = MSB

Example of a common resource

Education in a public school (grades K-12)

True or False: the demand curve for a luxury is less elastic than the demand curve for a necessity

False; the demand curve for a luxury is more elastic than the demand curve for a necessity

Ordinal measure

For utility theory --> all we need is to assume the consumer is able to rank or order preferences and so all we need is a measure preserving this ranking

Example of a qausi-public good

Hiking in a large park (no congestion) surrounded by a fence

Who has preferences?

Individuals/Households

Negative income effect

P falls, income rises consumption falls and reduces substitution effect

Who is interested in elasticity?

Policy makers e.g. gasoline demand (response to tax); oil response to p-rise; effectiveness of sin taxes (cigarettes, alcohol) Market participants especially demand side e.g. change in sales from a change in price

Production externalities

Pollution Knowledge (+ve)

Example of an industry that produces a negative externality

Poultry processing plants that deposit waste into rivers thereby polluting the rivers Imposing a cost of production on society that is not paid for

What happens to Q if P falls in terms of revenue

Q rises revenue rises because Q rises but falls because P has fallen

Point vs. Arc (or range) elasticity

Slope and P/Q are generally changing along demand curve Measure only correct for small changes in P and Q - if changes are large (discreet), then measure of elasticity should be based on a midpoint or average of P and Q

Externality

Spillover; not "internal" Not considered by producers or consumers in their decisions: producers not paid or do not pay cost Similarly, consumers create effect for which they're not compensated or do not pay Marginal cost/Marginal benefit that is not taken into account by the producers or consumers Can be positive or negative

Example of a product with a large price elasticity of demand (in absolute value)

Tide liquid detergent

If demand is perfectly elastic, then what is the effect of an increase in price?

a decrease in quantity demanded to zero

Cardinal measure

a measure which uses actual numbers

Difference between total U and marginal U

addition to total U from consumption of an additional unit of a good/service

example of a positive cross-price elasticity of demand

an increase in the price of a substitute for iPads will lead to an increase in the quantity of iPads demanded

What is the key determinant of elasticity?

availability of substitutes if there are close substitutes, then demand will be responsive.

How does a household maximize U?

depends on prices: Px, Py

Example of availability of close substitutes when it comes to elasticity

if there are few substitutes for gasoline-based transportation then a rise in price may result in a relatively small change in quantity the elasticity would be less than 1 if the price of Domino's rises by say 5%, then "lots" of people are going to buy Mike's pizza, resulting in a more than 5% fall in demand for Dominos --> demand is elastic

Unit elasticity

implies revenue does not change with respect to a change in price

If the income effect is positive

income and substitution effects work in the same direction a rise in price lowers income and therefore lowers demand adding to the substitution effect which causes demand to fall

An increase in the price of a substitute for iPads will lead to ______ in the quantity of iPads demaded?

increase

If demand is inelastic, a given increase in demand will cause equilibrium output to...?

increase more, the more elastic is supply

When marginal social benefits exceed marginal private benefits, subsidies can...?

increase output to achieve efficient outcomes

if demand is elastic, an increase in productivity will cause equilibrium output to...?

increase relatively more in percentage terms than price will fall, and firms will increase

Social security is ______ to inflation

indexed recipients are compensated fully for the erosion of purchasing power

What happens to the indifference curve when it comes to perfect substitutes and perfect complements?

indifference curves will be a straight line (substitutes) or a right angle (complements)

On the lower part of a linear demand curve below the midpoint, the demand is...?

inelastic

decrease in price decreases/increases total revenue, so demand is...?

inelastic

The price elasticity of demand for a particular brand of raisin bran is, in absolute value, meaning...?

larger than the price elasticity of demand for all breakfast cereals.

When it comes to utility, what does households want to do?

maximize utility

What is elasticity the measurement of?

responsiveness

2 characteristics of goods and services

rival and excludable goods rival - if I have more, there's less for you excludable - the supplier can exclude you from receiving good of service; you gotta pay to play

Consumer maximizes U subject to...?

subject to a budget constraint

If a consumer wants to maximize utility, what are they subject to?

subject to a budget constraint

Does income or substitution effect always dominate?

substitution

What are examples of market-based solutions to externalities?

taxes and subsidies

Private goods

the usual - rival and excludable