Microeconomics and Behavior Book (Test 1)

Using Indifference Curves to Describe Preferences

Indifference maps can be used to portray differences in preferences between two consumers Difference in taste is captured by differing slopes of indifference curves

Using cost-benefit analysis, try to analyze the effects of a severe recession like the one begun in 2007 on the decision to attend college. Would you be more of less inclined to put off college or begin college now if you are a high school graduate this year?

Many factors might be considered. If you can't find a job now the opportunity cost of going to college is reduced. If you feel the job opportunities will still be scarce after col-lege or if you believe there will be so much change in labor markets that your present interests will be less useful after college, then the benefits of attending college go down. If your family's income is at risk due to the recession and borrowing for education would be necessary, then the cost of college rises. The net effect of all these and other factors make it difficult to predict whether college enrollment will rise or fall in these recession years.

When Matt adds all his costs and divides them by the number of computers pro-duced, he has an average cost per computer of $800. He offers a computer to his father for $600. His father hesitates because he does not want Matt to pay $200 of his computer. Matt says, "Don't worry dad, I'm not losing money on the computer". Explain how Matt might be telling the truth.

Matt is truthful if the marginal cost of producing the computer is $600 or less even if the average cost is $800. Since the fixed costs of the operation will be paid whether Matt sells a discounted computer to his dad or not Matt is really not sacrificing them as an opportunity cost of his dad's computer.

Convexity and Preference Ordering

Mixtures of goods are preferable to extremes; this property conveys the sense that we like balance in our mix of consumption goods

We must define and measure costs and benefits

Monetary values are a common denominator

How do people choose among alternatives?

No choice is necessary if you can do it all and possess everything, including endless time. If this were the way the world worked, we would have no choices, no scarcity, and no economics. Unfortunately, we are limited in numerous ways, so we have to make choices. These choices are best made if we know which options will serve our objectives best. If we get benefits from a particular course of action that costs us nothing, it makes sense to take the action. But rarely is any action costless. Determining the costs of an action is one of the most misunderstood and abused processes in every-day life, whether one is running a business or trying to decide whether to study or go to a football game. People do things every day that cost them more than the benefits they receive from the action. They are less satisfied than they could be. Cost and benefit calculations are often flawed because of hidden costs or the human tendency to base decisions on how things seem rather than on how they real-ly are.

Income and Demand

Normal goods = quantity demanded rises as income rises Inferior goods = quantity demanded falls as income rises - abandon these goods for high quality substitutes

Costs and benefits are reciprocal

Not incurring a cost is the same as getting a benefit Not getting a benefit is the same as incurring a cost

Pitfall 1: Ignoring Implicit Costs

One pitfalls is to overlook costs that are not explicit People tend to ignore the opportunity cost of activity The art in applying the concept correctly lies in being able to recognize the most valuable alternative that is scarified by the pursuit of a given activity

Determinants of Supply

Technology Factor prices The number of suppliers Expectations Weather

The British redcoats in the American Revolutionary War lost many sol¬diers be-cause of the rather strange method of lining up in rows wearing a bright color and marching in the open. The colonials hid behind trees and shot at the easy targets. Without economics, one might consider the British rather stupid. With economics, there is a good explanation for their practice if one assumes that the colonials were highly motivated sol¬diers seeking to gain freedom while the Brit-ish soldiers were not very ex¬cited about the war. Start the analysis with several assumptions: a. The soldier's first objective is to stay alive and the second is to win the war. b. The best way to stay alive is to quietly leave the army. c. The general's first objective is to win the war. d. If soldiers pursue their objective, they will desert. What might the general do to pursue his objective? Write out the general's cost¬ benefit thinking as he plans his attack strategy.

The General reasons that, although the cost in soldiers will be high, he must put them in-to a formation and have them wear colors that will make desertion very obvious and, therefore, very costly. If the costs of staying with the army are less than the costs of deserting, the General believes he will be able to maintain an army. The inaccuracy of the guns may actually have meant that the cost in soldiers was much less than it ap-pears to the person familiar with modern weapons.

Technology and Supply

The amount suppliers are willing to offer at any price depends primarily on their costs of production These costs are closely linked to technology

Budgets involving more than two goods

The consumer has lots of options and is making decisions between N number of goods

Decisions to proceed are made when the benefits of doing something exceed the costs of doing it.

The costs and benefits must be the full opportunity costs and benefits. The calculations are usually unconscious or not thought of as explicit calculations. People simply behave as if they make the calculations.

Reservation Price

The price at which a person would be indifferent between doing x and not doing x - if you are rich, it will tend to be higher than if you are poor, because a given amount of money will seem less important

Matt has studied the personal computer market in his town and has examined his sales history. He believes an additional computer could be sold in the communi-ty for each reduction in price of $1. He also believes that at $2,500 the last cus-tomer in town would do without a computer. How would you represent algebrai-cally the demand function for computers in the town?

Since no one buys at $2,500 the vertical intercept is $2,500. The slope is - 1 because for every dollar drop in price the market would sell one more. Therefore the horizontal intercept is also 2,500. Accordingly the demand is P = 2500 - Q.

The economic naturalist finds that rational choice economic theory is help¬ful in explaining many things in life. I recently observed that $1 bills in the church of-fering plate are folded up more times that larger bills. Is there a rational choice explanation for this phenomenon? Explain.

Small givers are embarrassed and seek to hide their lack of generosity. It is in their inter-est to appear more generous than they are so they hide the number on the bill by fold-ing it.

The Economic Naturalist

Someone who uses basic economic concepts to make sense of observations about all aspects of everyday life.

Pitfall 2: Failing to ignore sunk costs

Sometimes an expenditure make seem relevant when in reality it is not Sunk costs should be ignored Sunk costs have already happened and will be the same whether or not you make your decision Exp) eating additional food just to get your money's worth is not a sensible decision strategy

Kinked Budget Constraints

Sometimes budget constraints are kinked lines book example: the opportunity cost of electricity depends on how much the consumer has already purchased

Prices of Substitutes and Complements and Demand

Substitutes: an increase in the price of one will tend to increase the demand for the other Complements: an increase in the price of one good decrease demand for the other good

Common pitfalls in decision making

1. Ignoring implicit costs 2. Failing to ignore sunk costs 3. Measuring costs and benefits as proportions rather than absolute dollar amounts 4. Failure to understand the average-marginal distinction

Cost and benefit calculations are often flawed because of hidden costs or the human tendency to base decisions on how things seem rather than on how they really are.

1. The full cost (opportunity cost) of an action is underestimated because some costs come in the form of oppor¬tunities sacrificed rather than dollars paid or in the form of social cost not borne by the decision maker. 2. Some costs are going to be paid whether an action is undertaken or not. These sunk costs are thus not relevant to the choice at hand and to count them in the cost assessment of a decision is to overestimate cost. There are times when emotion connects a past sunk cost with a present decision so that people make choices that are at variance with economic principles. Ex-amples in the text include the decision to eat less pizza because of a nice gesture from the owner or the decision to stay home from the concert when a storm occurs because the ticket was given instead of pur¬chased. 3. The absolute value of a cost or benefit is skewed by its proportion of the total cost or benefit being considered. The Walmart example in the text il-lustrates how differently people might consider a $10 saving depending on the size of the purchase. It is dollars that are saved, not proportions even though it may feel as if proportions matter 4. In considering whether to increase some activity, like launching boats in the text example, it is common to count the average cost of the additional act rather than the marginal cost, which is an accurate measure of the added costs. Efficient decision making occurs when marginal benefits equal mar-ginal costs.

It is assumed that

1. consumers can decide between alternative market baskets with even very small changes in composition (completeness). 2. if a consumer prefers A over B and B over C, he also will prefer A over C (transitivity). 3. consumers want more rather than less.

Price Changes and Budget Shifts

The rise in the price of one good rotates the budget constraint inward and the x/y intercept stays the same The fall in the price of one good leaves the x/y intercept unchanged and the budget constraint rotates outward Changing both prices by exactly the same proportion gives rise to a new budget constraint with the same slope as before (the opportunity cost also remains the same as before) The effect of double the prices of both food and shelter is to shift the budget constraint inward and parallel to the original budget constraint

Microeconomics

The study of how households and firms make decisions and how they interact in markets

Macroeconomics

The study of the economy as a whole

Pitfall 3: Measuring cost and benefits as proportions rather than absolute dollar amounts

The tendency to think in percentage terms when comparing costs and benefits causes trouble When using the cost-benefit test, you should express costs and benefits in absolute dollar terms, mot proportions. Comparing percentages is not a smart way to make these decisions.

Opportunity cost of activity

The value of all that must be sacrificed to do the activity

One of the most significant factors that appears on both lists is the price of the product being considered.

This makes it convenient to relate on the same graph the amount demanded and supplied. The relationship of price and consumer's quantity demanded is inverse, as shown in Figure 2-1, while supply and price is positively related, as shown. When a price falls, consumers are attracted to more of the good and they also have a bit more money to spend on it. The producer's reac¬tion to a price fall is to offer less for sale because all the high-cost units will now not be produced. Movements along the demand curve are called changes in quantity demanded, and movements along the supply curve are called changes in quantity supplied.

Indifference curves when there are more than two goods

Where there are more than two, we can construct indifference curves by using the same device we used earlier to represent multigood budget constraints good X and composite good Y equilibrium occurs when the consumer reachers the highest indifference curve attainable on his budget constraint

The optimization process can also be developed by using a utility function statement.

Using this method, which in your text is shown as the equation U(F,S) = FS, a set of indifference curves can be derived. The slope of the indifference curves is shown to equal the ratio of the marginal utilities of the two commodities in the consumer's market basket. Equating the slope of the indifference curve (MUf/MUs) with the slope of the budget line (Pf/Ps) will show where a person maximizes welfare by consuming so that the last dollar spent on each item brings the same amount of utility (MUf/Pf = MUs/Ps). Indifference curve analysis requires a consumer to make ordinal judgements about which market basket is preferred. No cardinal measurement of utility is required. Calculus can be used to show this maximization process.

The role of economic theory

We judge economic theory not by how accurate its central assumption is but by how well its predicts behavior Useful insights into our behavior can be gained by assuming that we act as if governed by the rules of rational decision making Economic models provide useful guidance for decisions

Horizontal interpretation of the demand curve

describes the demand curve as a schedule telling how much of a product consumers wish to purchase at various prices

Composite good

in a choice between a good X and numerous other goods, the amount of money the consumer spends on those other goods this convention enables us to think of the composite good as the amount of income the consumer has left over after buying the good X and it is the amount the consumer spends on goods other than X

Corner Solution

in a choice between two goods, a case in which the consumer does not consume one of the goods indifference curves that are not strongly convex are characteristic of goods that are easily substituted for one another; corner solutions are more likely to occur for such goods and are almost certain to occur when goods are perfect substitutes

Real price of a product

its price relative to the prices of other goods and services

Pitfall 4: Failure to understand the average-marginal distinction

"Should I increase the level by which I am currently engage in activity x?" Must compare the cost and benefits on an additional unit of activity The cost-benefit rule tells us to keep increasing the level of an activity as long as its marginal benefit exceeds its marginal cost. Knowing average cost and average benefit does not enable us to make a logical decision.

The four properties of preference orderings imply four important properties of indifference curves and indifference maps

1. indifference curves are ubiquitous - assured by the completeness property 2. indifference curves are downward-sloping - upward sloping would violate the more-is-better property 3. indifference curves (from the same indifference map) cannot cross - it would have to violate at least one of the assumed properties of preference ordering 4. indifference curves become less steep as we move downward and to the right along them - implied by the convexity property

Two independent reasons for the quantity demand to fall when price rises

1. many people switch to a close substitute 2. people are not able to buy as much as before

The amount of a commodity that producers wish to sell in the market depends on:

1. product price 2. input prices 3. producer technology 4. expectations

The amount of a commodity that consumers wish to purchase depends on a number of things, including the following:

1. product price 2. prices of substitute and complementary goods 3. income of consumer 4. number of consumers 5. expectations

(Refer to the Appendix for Chapter 3) If Curt's utility function is U(F,S) = F1/2S, which of the following coordinates is not on the indifference curve that generates 2 units of utility? a. F = 1, S = 2 b. F = 4, S = 1 c. F = 10, S = .3 d. F = 16, S = .5 e. All of the above coordinates are on the given indifference curve.

20. give a utility of 2 while c provides less utility than 2.

Supply curve

A curve that shows the relationship between the price of a product and the quantity of the product supplied. for a supplier to be willing to sell its product, its price must cover the marginal cost of producing or acquiring it Upward sloping because costs increase as quantity increases, substitution

Indifference Curves

A graphical representation of preferences that shows different combinations of goods producing the same level of satisfaction. An indifference curve permits us to compare the satisfaction implicit in bundles that lie along it with those that lie either above or below it Any bundle that lies above an indifference curve is preferred to any bundle on the indifference curve Any bundle on the indifference curve is preferred to any bundle that lies below an indifference curve

Change in the quantity demanded

A movement along the demand curve

Change in the quantity supplied

A movement along the supply curve

Completeness and Preference Ordering

A preference ordering is complete if it enables the consumer to rank all possible combinations of goods and services

Price supports

A price floor for agricultural products to benefit farmers Require the government to become an active buyer in the market A purpose of these price supports is to ensure prices high enough to provide adequate incomes for farm families In practice, they are costly and inefficient

Change in demand

A shift in the entire demand curve

Change in supply

A shift in the entire demand curve

17. Which of the following would be true of a person who was totally homo economicus? a. she would never vote in elections. b. she would never go to church c. she would never marry. d. All of the above are right answers.

A, the costs of studying candidates and going to the polls almost certainly outweigh the expected benefit of one vote. There can be significant private benefits from the other options.

Tampering with the market price leads to inefficiency.

Allocation using a first-come-first-served method reduces consumer welfare. Price fixing results in disequilibrium outcomes.

Trade-offs between goods

An important property of a consumer's preferences is the rate at which he is willing to exchange one good for another

Another way to see the desirability of equilibrium is to recognize that the de-mand curve measures the extra benefit received from each additional item bought, and the supply curve measures the cost of each additional item produced.

Any point to the left of equilibrium means that, for that item, the benefit exceeds the cost. Likewise, for all points to the right of equilibrium, the costs are greater than the benefits. Chapter 1 showed why when B > C the action is taken. (In this case, the item is bought.) Also when C > B the action is rejected. (In this case, the item is not purchased.) Thus where supply equals demand, the purchasing stops and equilibri-um is reached. The sum of the net benefits of each participant in the market is max-imized at this point, and therefore equilibrium is the standard against which other outcomes are measured.

Marginal rate of substitution (MRS)

At any point on an indifference curve, the rate at which the consumer is willing to exchange the good measured along the vertical axis for the good measured along the horizontal axis; equal to the absolute value of the slope of the indifference curve. - the absolute value of the slope of the indifference curve at that point - whereas the slope of the budget constraint tells us the rate at which we can substitute food for shelter without changing total expenditure, the MRS tells us the rate at which we can substitute food for shelter without changing total satisfaction - MRS declines as we move downward to the right along an indifference curve; indifference curves with diminishing rates of marginal substitution are thus convex when viewed from the origin

Market equilibrium is the place where supply and demand intersect.

At that point all sellers who want to sell at that price can find buyers and all buyers who want to buy at that price can find a purchase.

Supply and Demand Curves

Basic tool for analyzing market outcomes

This year you paid a room and board charge at your school that gives you all you can eat for 20 meals a week. For next year the administration is considering going to a credit card charging system where students swipe their cards through card readers for each item they eat. There is an individual price on each item that reflects its cost. Use the words sunk cost and marginal cost in a paragraph to describe what you think will happen to the quantity of food consumed, and the amount of food wasted.

Because your board payment is a sunk cost, you are inclined to eat until the next unit of food brings you no marginal benefit since the last unit of food is free as far as you are concerned. Therefore you eat more than you would if you paid for each item separate-ly. Because you will be more careful to take only what you will eat, less food is wasted.

The Opportunity Set or Budget Constraint

Budget constraints is the set of all bundles that exactly exhaust the consumer's income at given prices; aka budget line - slope of the budget constraint is "rise over run" - the minus sign signifies that it has a negative slope

Next the main employer in the town outsources a significant part of the business overseas. What will happen to Matt's demand curve, his equilibrium price and the quantity of computers he sells? Assume that the last customer in town will now go without a computer if the price reaches $1,900 but that the customers still decline at the rate of one per $1 price increase.

By lowering the demand intercept to $1900 and setting the supply equal to demand, the new quantity is 800 and the new price is $1,100.

If he estimates that the industry supply function for computers in the town is P = 700 + .5Q, how many computers will be sold at equilibrium and at what price would the producers be selling?

By setting supply equal to demand and solving for Q the quantity sold is 1200. Putting quantity back into the demand equation gives a price of $1,300.

Tastes and Demand

Changes in preference or popularity of product/service

Properties of Preference Ordering

Completeness More-is-better Transitivity Convexity

Factor Prices and Supply

Cost of labor, capital, wages, etc.

Carl has a car loan of $2000, which costs him $20 per month in interest. Ernie's identical car is paid off. They both live in a house with Curt, who wants to bor-row a car for a month at Christmas break. Both Ernie and Carl have a policy of loaning their car to people who are willing to pay the average cost per mile. Ernie charges the same price for his car as Carl does. Curt insists that either Ernie is overcharging or Carl is under¬charging. Is Curt correct in his analysis? Explain.

Curt is wrong because he does not understand that both friends have the same cost per mile.

Supply and demand are complex functions influenced by many factors.

Demand for a good varies with the size of the population and with consumers' income, tastes, expectations, and response to other goods' price changes. Supply of a good depends upon existing technology, factor prices, the number of suppliers, and their expectations.

If the benefit of an activity exceeds the cost

Do it

If the cost of an activity exceeds the benefit

Don't do it

If the budget constraint is the same, the decision should be the same

Even without knowing anything about the consumer's preferences we can use budgetary information to make certain inferences about how a rational consumer will behave The rational choice model makes clear that the decisions should be the same if the budget constraints and preferences are the same, but people sometimes choose differently; the difficulty is often that the way different situations are described sometimes causes people to overlook the essential similarities between them

Expectations and Demand

Expectations about future income and price levels also affect current purchase decisions Someone who expects a higher future income is likely to spend more today People will often accelerate their current purchases of goods whose prices are expected to rise in months to come

When the income level and the prices of the two goods are known, then the combinations of X and Y that are available with that income are determined.

Experimenting on a graph with various income levels and prices, varying one at a time, will illustrate how these changes alter the set of possible market baskets available to the consumer. Increasing M in the equation above will increase the X and Y intercepts but not affect the slope of the line. Therefore an income increase is shown by a parallel rightward shift of the budget constraint. A student should observe the change in slope and location of the budget line equation shown above as income and commodity prices are varied one by one. Graphing each change will help you see how the market baskets available to the consumer are affected by income and price changes.

Matt offers a two year warrantee for his computers and Megan offers only a one year warrantee. One of Megan's friends learns that when Matt went to a two year warrantee his profits went up even with warrantee costs considered. Me-gan's friend passes on the information to her and then says: You should extend your warrantee to two years and you would have more profit. (True\False:Explain) The information about Matt's increased profit is a norma-tive statement and the comment that Megan should extend her warrantee is a positive statement.

False, Matt's profit increase is a statement of fact while the comment to Megan suggests she should change her policy. The word "should" implies a value judgment that Megan values profit more than leisure or some other activity.

Matt and Megan each have computer assembly companies in a small city. Matt is renting his facility and Megan had her facility given to her by her father. (True\False: Explain) From what we know so far, we would expect Megan to have lower production costs than Matt.

False. Megan has exactly the same costs as Matt because what is an explicit factory cost to Matt is an implicit factory cost to Megan. She could rent her factory for an alternative use and she is sacrificing that income by using the factory herself.

Using marginal benefit and marginal cost graphically

For activities that are continuously variable, it is often convenient to display the comparison of marginal benefit and marginal cost graphically The optimal amount of a continuously variable activity is the quantity for which its marginal benefit is just equal to its marginal cost.

Weather and Supply

For some products, specifically agriculture, nature has significant effects on the supply schedule

Rent Controls

Government imposed price ceiling for rent Leads to a huge shortage Because of price ceiling, prices can't rise - poorly maintained rental units - hidden fees - misallocations The main problem confronting the poor Is that they have too little money. Transferring additional money to the poor does more to help them than attempting to control the prices of things they buy

Expectations and Supply

If producers suspect a future price to be higher or a lack of availability, they will hold on to their inventories and offer the products to the buyers in the future, thus they can capture the higher price

Microeconomics is the study of how people choose under conditions of scarcity.

If the benefits of an alternative outweigh the costs, that alternative is chosen. Economic models are designed to help predict what choices will be made.

All these changes in quantities occur when price alone changes and when quanti-ties adjust to price changes the process is called the horizontal interpretation of de-mand.

If the reservation price is sought for any given quantity in the market, then the de-pendent variable is on the vertical axis and the process is referred to as the vertical interpretation of demand. In like manner, a supply curve has both a horizontal and a vertical interpretation. Any other alterations in the variables from the lists above are analyzed one at a time with price held constant, so they are seen as shifts to the right or left of the supply and demand functions. These shifts are called changes in de-mand or changes in supply.

With perfect substitutes, indifference curves are straight lines

If they happen to be steeper than the budget constraint, we get a corner solution on the horizontal axis If less steep, we get a corner solution on the vertical axis

Where multiple goods are available, one good can be traded off against a composite of other goods, which is measured as the amount of income remaining after the commodity in question is paid for.

In effect, the vertical axis of the graph measures the income remaining to spend on other goods when a specific amount of good X is consumed. The usefulness of these tools in understanding consumer choice and public policy outcomes is far greater than first meets the eye. In your text the food stamp case in Chapter 3 and demand analysis in Chapter 4 will illustrate this point.

Population and Demand

In general, the number of people who buy a product grows as the number of potential buyers grows

Determinants of Demand

Incomes Tastes Price of substitutes and complements Expectations Population

Once the market model is understood and modeled, the model can be used to explore the effects of all kinds of events and policies.

It is important to keep in mind that, as one changes the variables in the model, only one should be changed at a time. Otherwise, too much will happen at once and the cause of the changes cannot be identified.

(Refer to Appendix for Chapter 3 for this question.) Jerry gets pleasure out of going to parties and playing on the intramural softball team. His monthly utility function for these activities is: U = f(P,S) = 22P -P2 + 16S - 2S2 where P = parties and S = softball games. a. Assuming that Jerry's schedule allows him to maximize his pleasure without any constraints, how many parties and softball games will he participate in each month? b. At midterm the grades showed Jerry failing his intermediate microeconomics class, so his professor suggested that he restrict his outside events to a total of 5 each month. If Jerry takes the suggestion seriously, how many parties and softball games will he participate in? (Use either the Lagrangian or substitution method to solve this problem.)

Jerry will attend 11 parties and 4 football games each month until his grade report, after which he will go to 4 and 1/3 parties and 2/3 football games. He is so committed to his studies that he will leave before a game or party is over if he has studying to do. The answer to 7a is arrived at by taking the first derivative of the equation with respect to P and S and then setting the derivatives equal to zero. The answer to 7b involves substituting the budget constraint into the utility equation and then maximizing the function with respect to one variable. When either P or S is found in that manner, substitution into the budget equation will get the other value.

When speed limits were increased from 55 to 65 miles per hour a news item ap-peared in the Chicago Tribune , which showed that deaths on Illinois highways increased since the speed limits were raised to 65 mph. Assuming that the faster speed caused the deaths, does this prove that cost-benefit analysis was not used in the decision to return to the 65 mph speed limit. What is being implied if we do not go back to the 55 mph limit?

Life is being traded off against time. If we do not go back to 55 it is because we believe that the time saved with 65 mph laws is more valuable than the savings in life that would occur if we had 55 mph laws.

Choices are often made incorrectly because of common pitfalls in thinking.

People tend to ignore implicit opportunity costs. People consider sunk costs that should be ignored. The mind tends to see things as proportions of the whole rather than in absolute dollar amounts. Marginal analysis rather than consideration of averages is essential to good decision making when one is considering changes because the costs and benefits that really matter are those at the margin.

Budget shifts due to

Price changes Income changes - the slope and position of the budget constraint are fully determined by the consumer's income and price of the respective goods; change any one of these factors and we have a new budget constraint

The rationing and allocative functions of prices

Prices ration existing supplies of goods - Scarcity Prices signal to direct productive resources among the different sectors of the economy

Is there such a thing as a purely positive economic analysis? Is it possible for people to keep their value judgments out of data gathering and analysis or even the choice of problem to study in the first place?

Probably not, and the gulf between the two types of analysis is slowly being critiqued. Data is increasingly being understood in terms of perception, interpretation, and con-text.

If the algebraic expression relating income to expenditure is shown as M = PxX + PyY, show, using simple algebra, that the slope of the budget line is -Px/Py if good X is on the horizontal axis.

PyY = M _ PxX; Y = (M/Py) _ (Px/Py)X, which fits the form of a line where (M/Py) is the vertical intercept, _ (Px/Py) is the slope of the budget line, and X is the independent variable.

Would parents want their daughter or son to marry homo economicus?

Self-interest is one of the most important human motives. But it is not the only important motive. Self motives are important.

The Invisible Hand

Self-interested consumers often act as if driven by what Adam smith called an invisible hand to produce the greatest social good. Although sellers were seeking only to promote their own advantage, the ultimate beneficiaries were the consumers.

Income Changes and Budget Shifts

The effect of a change in income is much like the effect of an equal proportional change in all prices The new budget is parallel to the old with an equal slope (shifts inward or outward depending on if the budget is decreasing or increasing)

Supply and demand analysis is the basic tool for analyzing markets.

The law of demand shows that quantities purchased in a market are in-verse functions of price. Supply in a market is a direct function of price. When quantity is the dependent variable and price the independent varia-ble, a horizontal interpretation of supply or demand is involved. When the variables are reversed and price is the dependent variable the inter-pretation is vertical. (Be aware that, in contrast to standard procedure, in market analysis the independent variable is on the vertical axis rather than on the horizontal axis.) When put together these functions show an equilibrium price and out¬put as well as the surpluses and shortages that will come from dis¬equilibrium prices.

The Number of Suppliers and Supply

The more firm that can supply a good, the greater will be the quantity supplied of it at any given price

More-is-better and Preference Ordering

The more-is-better property means that more of a goods is preferred to less (all other things equal)

When the constraint line and the indifference curve are put on the same graph, showing all possible market baskets, the maximization process becomes one of trying to move out to the highest possible level of pleasure (indifference curve) without exceeding the constraint line, which is set by the income level of the consumer.

This movement to the northeast must necessarily stop when the indifference curve becomes tangent to the budget line, because any further movement would give the consumer a market basket that she could not afford. Since the slope of the indifference curve equals the MRS x for y and the slope of the budget constraint equals the price ratio between Px and Py, it is easy to see that the following statement will be true when the consumer has maximized her utility: MRS x for y = the Px/Py. The basket for X and Y will be continuously juggled to fulfill this equilibrium condition which maximizes utility subject to the budget limitations.

MRS = Absolute value of sloe on the budget constraint

This will always be the case when the best affordable bundle occurs at a point of tangency

Plane

Three goods in the budget constraint

Transitivity and Preference Ordering

To say that a consumer's preference ordering is transitive means that, for any three bundles A, B, and C, if he prefers A to B and prefers B to C, then he always prefers A to C - not all comparative relationships are transitive

Using this framework, it is easy to see why intrusions into the market that pre-vent equilibrium from being reached also limit the amount of satisfaction that the market can generate.

Too many seats sold in an airplane, rent controls on apartments, or price supports for agricultural goods are all cases in which the equilibrium quantity is either not reached or is exceeded because of the policy intrusion.

Megan buys 90 motherboards for her computers each month. They cost $50 each. If she ordered 100 in a month she would qualify for a quantity discount and pay only $49 for each. (True\False:Explain) Megan knows she can not sell more computers, but she knows she can sell the extra motherboards to Matt for $45 so she should buy 100 each month.

True. Even though her average cost per motherboard drops to $49 each and her average benefit from selling to Matt is only $45, she should buy the additional 10. The marginal cost of the extra 10 is only $400. (90x50 = 4,500 compared with 100x49 = 4,900) The marginal revenue from Matt for the extra 10 motherboards is $450. (10x45 = 4,500) Therefore Megan increases her profit by $50. This assumes Matt does not increase his sales and hurt Megan's sales.

Rational Consumer Choice

Underlies all individual purchase decisions Begins with the assumption that consumers enter the marketplace with well-defined preferences

Budget line equation

Y = M/Py- (Px/Py) X

If costs and benefits happen to be equal

You are indifferent

What is your strategy in taking multiple choice exams where each question has the same amount of points and there is a tight t-me limit? Do you work systematically from question 1 through the end or do you select questions based on some other criteria? Explain your strategy.

Your goal should be to maximize your total score. The best strategy would be to answer the easiest questions first and then proceed to more difficult ones leaving the hardest to last. The cost in time spent on each question will be the lowest if you can answer a question easily while the benefit of each question is the same. Thus if you run out of time you will have maximized your score.

Where the marginal rate of substitution cannot equal the price ratio,

a corner solution exists.

External cost of an activity

a cost that falls on people who are not directly involved in the activity External costs and benefits often motivate laws that limit individual discretion

Price floor

a minimum price for a good, established by law, and supported by government's offer to buy the good at that price

Bundle

a particular combination of two or more goods - the first number of the pair in any bundle represents the good measured along the horizontal axis

Positive question

a question about the consequences of specific policies or institutional arrangements

Normative question

a question about what policies or institutional arrangements lead to the best outcomes What ought to be/What should be

Preference ordering

a ranking of all possible consumption bundles in order of preference - preference ordering enables the consumer to rank different bundles but not to make more precise quantitative statements about their relative desirability - differs widely among consumers

Indifference Map

a representative sample of the set of a consumer's indifference curves, used as a graphical summary of her preference ordering bundles on any indifference curve as less preferred than bundles on a higher indifference curve, and more preferred than bundles on a lower indifference curve

Demand curve

a simple mathematical relationship that tells how much quantity is demanded at various possible prices (holding all else constant) downward sloping a summary of the various cost-benefit calculations that buyers make with respect to the good; the negative slope tells us that the cost-benefit criterion will be met for fewer and fewer potential buyers as the price of the product rises

Supply schedule

a table that shows the relationship between the price of a good and the quantity supplied the set of price-quantity pairs for which suppliers are satisfied

If all people can have all they want of something at zero price, we say that there is no scarcity of that item. a. Can you think of any such items? b. What about a sunset, air, rain, or friendship? In what sense are these things scarce?

a) Your list is accurate if all who want to enjoy them can do so free. b) Friendships take time to cultivate. To have a sunset or rain, you must give up sun-shine.

Supply curves tend to be upward sloping in part because a. suppliers produce the least costly, easy-to-produce units first. b. producers become confident that they can charge more as they get bigger. c. inflation affects larger firms more than smaller firms. d. of all the above.

a, Diminishing returns set in as the variable input becomes heavily used.

At an auction of famous paintings in New York the auctioneer starts hearing bids at a. a price below equilibrium where excess demand exists. b. a price above equilibrium where excess supply exists. c. the equilibrium price below which no bid would likely be made. d. a price below equilibrium where excess supply exists.

a, In "Dutch auctions" the price begins above the equilibrium and the first bid takes it. In New York the price begins low and builds up as bidders drop out and the quantity demanded falls.

All points on or below a budget constraint a. are attainable with the given income. b. are equally desirable. c. represent market basket combinations that exhaust the income available. d. are described, in part, by a, b, and c above.

a, It is impossible to know what is desirable from a simple budget line.

One of the following statements describes a stock measurement rather than a flow measurement. Which is a stock? a. I am a millionaire. b. I earn $10 an hour. c. My weekly market basket is 2 units of food and 5 units of shelter. d. Our printer produces 10 pages each minute. e. None of the above is a stock measurement.

a, It is the only one that does not specify a time period.

Which of the following should be counted in the charge for lending your car to your roommate if your intention is not to gain benefit from such a rental? a. a portion of the regular maintenance charges b. a portion of the insurance payment on the car c. part of the license fee of the car d. some of the fee the college charges you for parking your car e. None of the above should be counted in your charges because only gas is not a sunk cost.

a, Maintenance is the only expense that will go up for you as your roommate uses the car.

Which of the following statements is false? a. Macro tries to explain how entrepreneurs go about profit maximization. b. Micro examines the process of individual markets in the economy. c. Macro explores the causes and cures of inflation. d. All the above are false.

a, Micro, not macro, does this.

A per unit tax on the seller and a price support have a similar effect on a market because a. both raise the price at which the good sells. b. both raise the amount of a good exchanged in the market. c. both leave excess supply that needs to be purchased by the government. d. both result in the cost of production exceeding the value the consumer gets.

a, Only "a" is definitely true of both policies.

The narrow self-interest of Homo economicus may work to his disadvantage more than he realizes because a. there are implicit social costs to blatant self-interested behavior. b. the pursuit of self-interest is no fun. c. there are no social benefits from individual self-interested behavior. d. all the above are true.

a, People often detest the egotist and avoid him, thereby limiting his options for utility. In a sense, option b would be an answer except that when the disutility of "no fun" outweighs the utility gained from the activity in question, then the behavior ceases.

Economic theory can best be judged by a. how well it predicts outcomes. b. how well it describes people's motives. c. how realistic are its assumptions. d. the amount of money economists make.

a, Prediction is the main objective according to mainstream theory, but the ability to de-scribe and understand the system is gaining credence as economists start to talk about storytelling and rhetoric as part of the method of doing economics.

After struggling for four weeks in a calculus course, a student came to my office for advice. I listened to his story and found he was nearly failing but did not want to drop the course. The deciding factor in his mind was that he had put in such hard work, which would be wasted if he dropped the course. If the term were just beginning, he said, he would drop the course even without picking up another to replace it. Given this, what advice should I have given if I felt he was working up to capacity? a. Drop the course now. b. Keep trying to salvage a passing grade. c. Wait until the deadline for drops and then decide. d. Offer consolation, but say I had no clear way of knowing whether he should change his mind and drop the course.

a, Sunk costs are irrelevant and the hard work is over, never to be recovered. However, one might argue that the ongoing psychological effect of being defeated in a course is a cost that is not sunk at the moment. The psychological pain of continuing the struggle presumably is involved in the present decision-making process.

If food is on the vertical axis and shelter is on the horizontal axis, a set of indifference curves that are quite steep with respect to the horizontal axis a. reflect a preference pattern that generally values shelter high rela¬tive to food. b. imply that food has a higher relative value than shelter for this con¬sumer. c. say nothing relating to how the consumer feels about the two goods until a budget line is introduced. d. mean that the two goods are perfect substitutes.

a, The axis toward which the slope is steepest will be the most valued good.

The law of demand states that a. people buy more of a commodity when its price falls. b. people buy more of a commodity when their incomes rise. c. supply creates its own demand. d. people are skeptical of free goods.

a, The change in quantity that results from a price change is what this "law" refers to.

Affordable set

bundles on or below the budget constraint; bundles for which the required expenditure at given prices is less than or equal to the income available

If a price is artificially set below equilibrium in a marketplace, which of the fol-lowing will be true? a. The benefit of the last unit sold will exceed the cost of that unit. b. The cost of the last unit sold will exceed the benefit of that unit. c. The cost of the last unit sold will equal the benefit of that unit no matter where the price is. d. It is impossible to know the costs and benefits from the information giv-en.

a, The low price reduces the quantity supplied and moves the consumer back up the demand curve where the marginal benefit exceeds the cost of the last unit consumed.

I checked out a painting from the library to hang in my home office, but when I got it home it was much too big for my wall. When I took it back the library hung it on a wall in the main reading room and there it looked too small. The explana-tion of why the same picture can look both too small and too big is the same as the explanation for which story from your text. a. Walmart case. b. Should I go skiing today? c. Should I drive to Boston or take a bus? d. How many boats should Tom launch? e. More than one of the above.

a, The picture is viewed in relationship to the size of the wall on which it hangs. There-fore, the explanation is pitfall 3 in your text where saving at Walmart is viewed in rela-tionship to the amount of money spent.

An auction of a Rembrandt painting is an illustration of a market activity per-forming a. the rationing function. b. the allocative function. c. both the rationing and allocative functions. d. neither the rationing nor allocative function is relevant with a Rembrandt.

a, There is no way to allocate more resources toward additional Rembrandts anymore.

In Example 1-2 in your text, you do not go skiing because the benefits of $60 are less than the costs of $85. Now add one new factor to the decision. Part of the reason you are willing to work for the professor for nothing is that a friend is also working for the professor and you intended to work with her that day. The pleasure of associating with the friend is worth $15 to you, but now that friend decides to go on the skiing trip with the group that asked you to go. Your cost-benefit calculation will change in which of the following ways? a. Costs of going drop $15 and benefits go up $15 so I go skiing. b. Costs of going stay the same but benefits of going increase by $15 dollars, so you still stay and work. c. Both costs and benefits of the trip go up $15 so you still stay home and work. d. Nothing is changed since the value of a relationship is not a real opportunity cost.

a, What was a cost of going becomes a benefit, so costs fall by $15 and benefits rise by $15.

Consumer preference patterns are the next building block of consumer theory.

a. Consumer preference orderings must be complete, transitive, and more must be preferred to less. b. These qualities lead to indifference curves that are negatively sloped, nonintersecting, and continuous. c. The slope of the indifference curves shows the rate at which the con-sumer would like to exchange one good for the other. This is called the marginal rate of substitution. d. A diminishing marginal rate of substitution is common and results in an indifference curve that is convex to the origin. e. Perfect substitutes have straight-line indifference curves and perfect complements have L-shaped curves.

Rational consumer choice theory begins with a budget constraint or opportunity set.

a. The slope of the constraint shows the relative price ratio of the two goods under consideration. b. The location shows the amount of income that is available. c. One good can be used as a composite good that can represent money spent on goods other than X.

Macro

aggregates the micro behavior and looks at the summed categories.

Free markets and the poor

all markets may be in equilibrium and yet many people may lack sufficient incomes to purchase even the bare necessities of life concern for the well-being of the poor motivates most societies to try to intervene but these intervention often produce unintended harmful consequences many critics of the market system complain that is unfair to ration goods and services by asking how much people are willing to pay for them

The "invisible hand" described by Adam Smith

allocates resources to their best use as people pursue their preferences, but Smith also believed that, by nature, humans are inclined to consider values and other variables outside the self-interest framework.

Flows

amounts per unit of time - consumption is always measured as a flow

Applications of this theory include

an analysis of the food stamp program and gift giving.

Shifts in the market curves

are called changes in demand or supply, respectively.

Indifference curves

are usually curved in a manner convex to the origin in order to show that consumers gain less benefit from an additional unit of a good if they already have large quantities of the good (diminishing mar¬ginal utility). These indifference curves could be straight lines or even concave to the origin if more of a good does not diminish taste for the good, or if people are inclined to want more the more they have of a good.

Adjustment to equilibrium

at any price other than equilibrium price, one side of the market is dissatisfied dissatisfied sellers: downward pressure on price will persist as long as there remain any dissatisfied sellers (AKA until price falls to its equilibrium value) dissatisfied buyers: upward pressure on price will persist until price reaches its equilibrium value the adjustment toward equilibrium results more or less automatically from the natural reactions of self-interested individuals facing either surpluses or shortages

Which of the following is a normative statement? a. Economists have a higher life expectancy than do miners. b. Economists deserve to have lower life insurance rates than do miners. c. Economists receive higher pay on the average than do miners. d. Economists pay more taxes on the average than do miners.

b, Deserve is a value judgement. Someone else may not think we deserve lower rates.

Mathematicians can tell you where on the pool table a cue ball will have to be hit in order to make a shot. They do this by calculating the angles involved in the shot. If a champion pool player hits a particularly tough shot, it means that he a. calculated all the angles like the mathematician. b. practiced enough so that trial-and-error learning makes him as good as if he knew the mathematics. c. was lucky. d. hired an economist to model what the perfect shot would be like.

b, Practitioners get, by trial and error, where theoreticians predict they will go using models. In effect, the practitioner behaves "as if" she worked with the model.

In Example 1-6 of your text, the refunded pizza eaters ate less than the non-refunded eaters did. This illustrates that a. Rational choice analysis is precise and accurate even in pizza eating. b. Context, emotions and subjective feelings effect behavior in ways that rational choice would not predict. c. Rational choice analysis is not helpful in evaluating eating behavior because eating is a need rather than a want. d. People with less money tend to eat more food.

b, Rational choice analysis does not predict well when factors like emotions and sub-jective feelings are involved in behavior.

The auction for a famous painting fits your text's description of a. a horizontal interpretation of demand. b. a vertical interpretation of demand. c. both horizontal and vertical interpretations since the price keeps chang-ing. d. neither horizontal nor vertical because paintings are one of a kind.

b, Since quantity is set the auctioneer is trying to find the reservation price of the per-son most interested in the painting.

Which of the following is a true statement about rational consumer choice? a. Diminishing returns negate the usual "more is preferred to less" assumption. b. People constantly seek to improve their position. c. People must be able to measure numerically the amount of pleasure they receive from a market basket of goods. d. all of the above are true.

b, The more is preferred to less assumption relates to answer b.

The text example suggests that airplane food is inevitably worse than restaurant food. This is because a. Air travelers tend to appreciate good food less than the general public. b. The cost of preparing exquisite food is greater in airplanes than in restaurants. c. Food loses some of its flavor at high altitudes. d. Food is a fixed cost that airlines try to avoid.

b, The quality of food is based on cost-benefit analysis and the cost of kitchen space is much higher in the sky than on the ground because high paying seats would be lost.

I once bought an expensive can of varnish for a floor I intended to sand and varnish. I soon realized I could not do as good a job as a professional sander would do. However, because I had already bought the varnish and the contractor would use only his own varnish, I did the job myself. In this case I a. effectively used cost-benefit analysis. b. failed to ignore a sunk cost and therefore made a bad decision. c. did not count all the explicit costs of doing the job myself. d. was led by an invisible hand to make the right choice.

b, The varnish was a non-returnable sunk cost. The relevant question was: If I was starting from scratch with what I know now, what would I do? (The truth is I really did call in a floor expert.)

If the price of a good shown on the vertical axis of a budget graph is cut in half and the price of the good on the horizontal axis is cut by 25%, then the budget constraint a. shifts left and becomes steeper. b. shifts right and becomes steeper. c. shifts left and becomes flatter. d. shifts right and becomes flatter.

b, The vertical intercept goes up proportionately farther than the horizontal intercept moves right.

Scarcity, as economists use the term a. is slowly being eliminated from large parts of the world, and therefore microeconomics is focusing more on choices where scarcity is not pre-sent. b. is a fact of life for both rich and poor. c. means that it is impossible to get things that are important for normal well-being. d. would not be necessary for microeconomics to exist

b, among alternatives would still be necessary.

An equilibrium price

brings maximum welfare to the system.

Which of the following is a correct representation of the budget constraint in a world with only food and shelter, where M = income, Pf = price of food, Ps = shelter price, S = the quantity of shelter, and F = the quantity of food. a. M = Pf (S) + Ps (F) b. F = M/Ps - Pf/Ps (S) c. S = M/Ps - Pf /Ps (F) d. F = M/Pf - Pf /Ps (S)

c, A correct one is some form of M = Pf (F) + Ps(S).

When an agricultural price support is put on wheat to boost farmers income a. the quantity of wheat demanded is greater than the quantity farmers want to sup¬ply at the support price. b. the marginal benefit of wheat is less than the marginal cost of the last unit of wheat supplied. c. there is less wheat consumed than would be consumed at the equi¬librium price if no price support was involved. d. all the above are true.

c, Because the price is above equilibrium price, the quantity demanded will be reduced.

If the price of gasoline rises dramatically, a. the quantity demanded for cars will decrease. b. the demand for commuter train rides will decrease. c. the demand for cars will decrease. d. the quantity of commuter train rides demanded will increase.

c, Cars are complementary to gasoline and a decrease in quantity demanded of gasoline will cause the demand for cars to shift left.

The years 2008 and 2009 have not been good years for retailers, many of whom have cut prices significantly. Using our terminology to explain this we could say that a. supply has increased and the quantity demanded has fallen. b. the quantity demanded has decreased as supply has shifted left. c. demand has fallen and the quantity supplied has fallen. d. demand has increased but supply has increased even more.

c, Consumers have spent less as their asset values have fallen shifting the demand curve left. This causes a movement down along the supply curve.

Markets are desirable for all the following features except one. Which is not true of markets? a. Markets provide signals that tell how much people value goods and ser-vices. b. Markets provide signals that indicate the cost of producing a good or service. c. Markets provide signals that lead toward a society's desired income dis-tribution pattern. d. Markets provide signals that encourage resources to flow toward their best use.

c, Distribution patterns are determined in markets, but desirability is not guaranteed.

If an indifference curve is convex from above (bowed outward), which of the following statements would be true? a. The more you have of a good, the less you desire additional units of the good. b. The less you have of a good, the more intense your desire for more of it. c. The more you have of a good, the more intense your desire for more of it. d. This type of indifference curve violates the more-is-better-than-less assumption underlying indifference curves.

c, Increasing marginal utility would be present for this case.

One day in the faculty house a professor was pontificating on how a college should approach new program proposals. He said, "If we can not do something at the highest standards of excellence we should not do it at all." Which of the following evaluations of this statement is correct. a. The professor is entitled to his opinion and economics can not make a judgement on his viewpoint. b. The professor is right because excellence maximizes benefits of a project.. c. The professor is wrong if the costs of going from near excellence to excellence exceed the value of the gain from such a change. d. The professor is right because doing something poorly can never be justified.

c, Most likely the marginal benefit of the last effort needed to reach excellence will be small relative to the benefit that might be gained from an equally costly project that didn't exist before, but now is a very good program. Thus the net benefit of programs that are less than excellent usually exceed the net benefits of programs designed to go from a position of near excellence to excellence.

Which of the following is an external cost of a community rock concert? a. The fee paid to the performers b. The loud music heard by rock lovers all over town who could not afford the tickets c. The loud music heard by rock haters all over town who did not want to attend the concert d. The extra business the local merchants received from the crowds that at-tended.

c, Rock lovers get an external benefit while rock haters absorb the cost of fighting off the noise.

The following two equations depict a market for wheat: P = 160 - 2Q and P = 10 + 48Q. Which of the following is true of this market? a. The supply function is the first of the two equations. b. The price at equilibrium is 140. c. The quantity at equilibrium is 3. d. The supply intercept implies that the earlier units can be produced free.

c, Set the two equations equal to each other and solve for quantity and then price.

An economic naturalist might ask all of the following questions except one. Which would not be a typical naturalist question? a. Why do city streets not have tolls while country highways sometimes do? b. Why do women's haircuts usually cost much more than men's haircuts? c. Should we legalize some illegal drugs? d. When is the best time for retailers to run their biggest sales?

c, The drug question requires value judgments indicated by the word should. The other questions relate to objective costs and benefits.

The story of oil supply restriction and price controls described on the first page of Chapter 2 in your text can be shown graphically on a simple sup¬ply and de-mand graph by starting from a given supply and demand and a. shifting supply to the right and setting the price above equilibrium. b. shifting the supply curve to the right and setting the price below equi-librium. c. shifting the supply to the left and setting the price below equilibrium. d. shifting supply to the right and setting the price below equilibrium.

c, The policy acts as a price ceiling.

On a graph of a preference pattern of food and shelter, food is on the vertical axis. The slope of the indifference curve at the relevant market basket is 3. If food is 4 times more expensive than shelter, the consumer is a. maximizing his pleasure. b. consuming too much shelter and not enough food. c. consuming too much food and not enough shelter. d. consuming more of both goods than he can afford.

c, The slope of the indifference curve is 3 and the slope of the budget line is only 1/4. Thus the two functions intersect at a point where movement to the right toward shelter will bring about a tangency and utility maximization.

Which of the following could also answer question 14 correctly? a. A new technology for producing tacos was found. b. The price of taco casings fell. c. High taxes have driven many beef ranchers out of business. d. All the events above would raise the price of tacos.

c, The supply curve of beef shifts left and so the supply of tacos does also.

Which statement is true of the optimization model presented in this chapter? a. If two individuals have the same marginal rate of substitution for two products they will be shown to consume the same market basket. b. A consumer who is at a corner solution considers the opposite good to be worthless. c. If the marginal rate of substitution of X for Y is greater than the ratio of the price of X to the price of Y, Then the consumer should consume more X. d. None of the above are true.

c, This implies that the indifference curve is steeper than the budget line, so a tangency point will move one further down the budget line with more X.

Which statement about consumer preferences is inconsistent with rational consumer choice analysis? a. Every additional Hershey Kiss I eat gives me less pleasure than the previous one. b. The more Hershey Kisses I eat the greater is my pleasure overall. c. I'm addicted to chocolate so the more Hershey Kisses I eat the more I want. d. Although I care about others I never give away any of my Hershey Kisses.

c. Increasing marginal utility is inconsistent with rational choice so addictions are not explained well by the theory without some modification.

(Refer to the Appendix for Chapter 3.)In order to maximize the utility function U = f(X,Y) that is constrained by the income limit M = PxX + PyY using the substitution method, all these steps are used except which one? a. Solve the income constraint for Y. b. Substitute the revised budget constraint into the utility function. c. Take the first derivative of the new utility function and set it equal to 1. d. Solve the maximized utility function for X. e. Use the budget constraint to find the remaining unknown.

c. Maximization involves setting derivatives equal to 0 rather than 1.

Adam Smith's invisible hand a. requires that economic actors are totally self-oriented. b. conceived of a transcendent being as governor of economic activity. c. allowed for human motivations more complex than homo economicus. d. referred to the government's role in the economy.

c. Smith had a rich understanding of the interdependence of human preferences and al-lowed for an impartial spectator as a guide to moral behavior.

Movements along the supply or demand curves that are induced by shifts in the opposite curve are called

changes in quantity supplied or demanded, respectively.

Market

consist of the buyers and sellers of a good or service - the best market definition will depend on the purpose at hand

Sunk costs

costs that are beyond recovery at the moment a decision is made

The market for tacos has become unstable. The American Heart As¬sociation says they contribute to heart disease, the price of cheese has fal¬len, the popula-tion has risen, and the real income of the population has fallen. In spite of all this, the relative price of tacos has risen. This could be explained by a. the fact that cheese is a complement rather than a substitute for tacos. b. the fact that tacos are inferior goods. c. the fact that people prefer heart attacks to alternative means of dying. d. any one of the answers listed above.

d, All of the options shift the demand for tacos to the right.

Using cost-benefit analysis to evaluate market efficiency, we could say that if the amount sold _______________________ for the last item sold. a. is less than equilibrium, the producer cost is greater than the consumer benefit. b. exceeds equilibrium, the producer cost is less than the consumer benefit. c. is at equilibrium, the producer cost and consumer benefit are equal. d. none of the above answers is true.

d, Because the demand curve represents the benefit received from the last unit bought and the supply curve shows the extra production cost of the last unit, the marginal ben-efit equals the marginal cost of that unit. Fewer amounts exchanged have benefits > costs and greater amounts exchanged have costs > benefits. Both of these would in-volve reduced welfare.

If I offer you a choice between pizza and ice cream and you say, "I don't care which I get so you pick," I can assume that your indifference curve a. is parallel to the pizza axis of the consumer choice model. b. is parallel to the ice cream axis of the consumer choice model. c. is L shaped d. has a slope of negative 1. e. is described by none of the above because I can't be sure what it is.

d, Because you are indifferent between the two, they are of equal value and would be traded on a one for one basis which would be a slope of -1.

Indifference curves that intersect would be illogical constructs because a. more is better than less. b. of diminishing marginal utility. c. of the transivity property of indifference theory. d. of both a and c above. e. of none of the above.

d, Compare the bundle of goods at the intersection with a bundle to the right on each curve.

16. Which of the following will help to get class started on time with better attendance? a. having the room door in the front of the classroom rather than in the back. b. holding class at 10 AM rather than at 8 AM. c. having a short quiz at the start of each class. d. all of the above would work to get class going. e. none of the above make any difference because students operate out of habit more than anything else.

d, Hopefully all the options will either increase the cost of being late or increase the benefits of being on time. Those who answered e may have trouble in the job market after college.

An upward sloping indifference curve is logical in rational choice analysis when a. one item under consideration is junk in your garage. b. buying more of one item decreases your total utility. c. a person reaches the satiation point and is inconvenienced by more of the good. d. any of the above are true.

d, In each case listed more of the competing good is need to keep utility constant so an upward slope results.

Rent controls a. set the price of apartments below equilibrium. b. result in a decline in the quantity of apartments supplied. c. reduce the overall welfare received by apartment dwellers as a group. d. do all of the above.

d, Items b and c represent the strongest arguments against rent control.

In a preference ordering exercise in which two baskets of goods are being considered, it is assumed by indifference theory that the consumer is able to a. measure the amount of pleasure expected from the preferred basket. b. say how much more one basket is valued over the other. c. calculate only the absolute value of the less desirable basket. d. make no absolute measure of the value of any of the market baskets.

d, Ordinal, not cardinal, measurement is possible in indifference theory. The ability to select one option over another in a pair is all that is needed for indifference theory to work.

The marginal rate of substitution between food and shelter for a given point on an indifference curve a. is equal to the absolute value of the slope of the indifference curve at that point. b. is equal to the rate at which the consumer is willing to exchange the two goods in the marketplace. c. reflects the relative values the consumer attaches to the two goods. d. is described, in part, by each of the above statements.

d, Refer to the proof of (a) in your text.

According to your text, low quality umbrellas in Manhattan sell for $10 on a rainy day and $7 on a sunny day. Starting from a rainy-day market equi¬librium price of $10, one can show graphically the most probable explana¬tion for the price drop by a. shifting the supply curve of umbrellas to the right. b. shifting the demand curve of umbrellas to the right. c. shifting the supply curve of umbrellas to the left. d. shifting the demand curve of umbrellas to the left.

d, Sunshine shifts the demand left.

Which statement is false? a. If golf green fees rise the quantity demanded of golf balls falls. b. If snow blower prices rise the quantity demanded of snow shovels shifts right. c. If the price of an electric cars falls the supply of gasoline cars shifts right. d. All of the above are false.

d, The demand, not the quantity demanded change in a and b. In c the demand for gasoline cars shifts right which causes an increase in quantity supplied rather than a shift in supply.

If the demand curve for a commodity is P = 10 - 2Q and then it changes to P = 12 - Q while supply remains unchanged, price will a. fall b. rise c. stay the same. d. either rise or fall or stay the same depending on the supply curve.

d, The intercept increase will push price up but the increased slope reduces price so the net effect can only be known when the supply curve is specified.

Which of the following does not have the same effect on the demand curve as the other three? a. The price of a substitute falls. b. The price of a complement rises. c. The good is an inferior good and the consumer's income rises. d. The consumer's income rises and the good is a normal good.

d, The other options shift the demand curve left.

At equilibrium price a. the maximum amount of net social benefit is realized from the com-modity being considered. b. all those who want to sell at that price can find buyers willing to buy at that price. c. all those who want to buy at that price can find a seller willing to sell. d. all the above are true.

d, The phrase "net social benefit" is important in (a) because a free good provides max-imum social benefit since it captures all the welfare under the demand curve.

Normative economics

deals with what should be

Homo economicus

does not attract others because egoistic motives ignore too much of the richness of life.

Equilibrium in markets

does not guarantee fairness for all.

You are an avid baseball fan. You root for Baltimore over the Yankees and the Yankees over Cleveland. If Cleveland and Baltimore play you don't care who wins. Which of these teams would you prefer to see in the World Series? a. Yankees b. Baltimore c. Cleveland d. Seattle e. unable to tell because transitive assumption is violated.

e, If Cleveland and Baltimore are equal then Baltimore can not be preferred to Cleveland as would be the case if transivity were to hold in this example.

Which statement is true of the demand curves shown in Chapter 2 of your text? a. The demand curves are individual consumers' demand curves. b. There is movement along a demand curve as the consumer's income ris-es. c. The demand curves show only desire for a product but not the ability to pay for the commodity. d. The demand curves shift to the right as price falls. e. None of the above are true.

e, The demand curves are market curves which imply effective demand, or ability to pay. Movements along a curve are due to price changes only.

Micro behavior

focuses on the individual and the organization

Diminishing MRS

means that consumers like variety

Some welfare properties of equilibrium

no reallocation can improve some people's position without harming the position of at least some other if price and quantity take anything other than their equilibrium values, it will always be possible to reallocate so as to make at lest some people better off without harming other no matter whether price starts out above or below its equilibrium value, a mutually beneficial transaction will always be possible

The economic naturalist

observes life and asks the question "why". Answers are often found by using the cost-benefit framework described in this chapter.

Interior solutions

problems where the best affordable bundle will lie at a point of tangency - where the MRS is exactly the same as the slope of the budget constraint

Positive economics

seeks to explore how the economy works.

Vertical interpretation of the demand curve

start with the quantity on the horizontal axis and then read the marginal buyer's reservation price on the vertical axis

Maximizing a consumer's utility requires

that the marginal rate of substitution equal the price ratio of the goods.

Excess demand

the amount by which quantity demanded exceeds quantity supplied when the price of a good lies below the equilibrium price shortage

Excess supply

the amount by which quantity supplied exceeds quantity demanded when the price of a good exceeds the equilibrium price surplus

Average benefit

the average benefit of undertaking n units of an activity is the total benefit of the activity divided by n

Average cost

the average cost of undertaking n units of an activity is the total cost of the activity divided by n

Budget triangle

the consumer is able to purchase any bundle that lies within the budget triangle bounded by it and the two axes

Law of demand

the empirical observation that when the price of a product falls, people demand larger quantities of it

Law of supply

the empirical observation that when the price of a product rises, firms offer more of it for sale

Marginal benefit

the increase in total benefit that results from carrying out one additional unit of an activity

Marginal cost

the increase in total cost that results from carrying out one additional unit of an activity

Price ceiling

the level above which the price of a good is not permitted by law to raise

If external costs or benefits are present,

the market is unable to allocate as efficiently.

The Best Affordable Bundle

the most preferred bundle of those that are affordable the more-is-better assumption implies that the best affordable bundle must lie on the budget constraint, not inside it; it intersects the budget constraint line only once

Consumer Preferences

the personal likes and dislikes that make buyers more or less inclined to purchase a good

Equilibrium quantity and price

the price-quantity pair at which both buyers and sellers are satisfied where supply and demand intersect at any other point, one party is dissatisfied

Allocative function of price

the process whereby price acts as a signal that guides resources away from the production of goods whose prices lie below cost toward the production of goods whose prices exceed cost - driving force behind the invisible hand - long run function

Rationing function of price

the process whereby price directs existing supplies of a product to the users who value it most highly - short run function

A utility function analysis using calculus will result in

the same conclusions that the indifference curve process has set forth.

Horizontal interpretation of the supply curve

we begin with a price, then go over to the supply curve to read the quantity that sellers wish to sell at that price on the horizontal axis

Vertical interpretation of the supply curve

we begin with a quantity, then go up to the supply curve to read the corresponding marginal cost on the vertical axis

Hyperplane or Multidimensional Plane

when we have more than three goods in the budget constraint

A decrease in demand

will lead to a decrease in both the equilibrium price and quantity

An increase in supply

will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity

An increase in demand

will lead to an increase in both the equilibrium price and quantity

A decrease in supply

will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity