Econ 1010 Midterm 1
Define Average Product of an Input (𝑨𝑷𝑳, 𝑨𝑷𝑲)
total output divided by the total amount of the input used
what is the formula for cost minimization?
𝑴𝑹𝑻𝑺 =𝑴𝑷𝑳/𝑴𝑷𝑲=𝑾/R
Define marginal utility
increase in utility from a small, one-unit increase in consumption of the good while holding consumption of all other goods constant.
What happens as I move down the indifference curve and what assumption of consumer preference supports that?
As you move down the indifference curve you experience diminishing marginal rate of substitution, supported by the assumption of preference for variety.
Difference between change in demand & change in quantity demanded?
Change in quantity demanded is movement along the curve in response to price changes and change in demand is a shift of the curve in response to a non-own-price factor that affects demand
Define DWL
Dead weight loss- the reduction in total surplus that occurs as a result of an external change, like regulation
Define Production Function
Describes how output can be made from different combinations of inputs 𝑸 = 𝒇(𝑲, 𝑳) where 𝑸 is quantity of output, 𝑲 is quantity of capital, and 𝑳 is quantity of labor.
Define "Equal Bang for the Buck"
Since 𝑴𝑹𝑺 is equal to the ratio of marginal utilities for the two goods, we can rewrite the optimum choice condition as: 𝑴𝑼𝑿/𝑷𝑿 = 𝑴𝑼𝒀/𝑷Y
Define Supply choke point
The price at which no producer is willing to supply the good
What is demand choke price?
The price where there is zero quantity demanded
What does the curvature of the indifference curve tell you?
The relationship between the basket of the two goods
What affects the size of the income effect?
The size of income effect depends on the fraction of the budget spent on the good: if the good plays a large role in total expenditure, a change in its price has a large effect on income. The sign of income effect depends on whether the good is normal or inferior.
What determines the magnitude of the change in equilibrium price and quantity?
The size of the shift & the slope of the curve that is not moving (elasticity of the non-moving curve)
Is my own (subjective) marginal value of a can of Coke always equal to that of Bill Gates and a poor person in Africa?
This is true if each of us actually buys nonzero amount of the good at the same price. This is not always the case for two reasons ... • some markets are simply not accessible to some consumers • consumers choose to buy nothing in certain markets because of preferences or budget constraints
What defines wether an input is fixed or variable?
Time horizon is the chief factor determining whether cost of a particular input is fixed or variable: • over short time horizons, many inputs are fixed, and costs associated with them are fixed • over very long horizons most inputs become flexible.
Define total cost and state formula
Total cost of producing and output. T𝑪 = 𝑾 × 𝑳 + 𝑹 × K
Cobb Douglas Formula?
U= X^𝜶 × 𝒀^𝟏−𝜶
Define spill over effects
When disturbances in one market happen the other gets affected and they continue to affect each other until a new equilibrium is reached between both markets
Define Firm
any producer, including physical persons, small firms or large corporations
Define perfect complements, and name some examples
are goods that are consumed only in fixed proportions. Ex: left and right shoe, shampoo and conditioner
Define perfect substitutes, and name some examples
are goods that the consumer is indifferent about trading at a fixed rate at any level of consumption of these goods, i.e. 𝑴𝑹𝑺 is constant. Ex: pepsi & coke
Intermediate Goods
are used as inputs in other production processes (e.g., wheat used to produce bread)
Define Production
describes the process by which inputs are turned into an output (a good or a service)
What is a constrained optimization problem?
find the basket of goods that maximizes her utility while at the same time fitting into her budget constraint
What are isoquants?
for a given output 𝑸 , isoquant charts all combinations of 𝑲, 𝑳 that can be used to produce this output. The curvier they are means that the inputs are complements and the straighter they are means that the inputs are substitutable
Define Final goods
good purchased by consumers (e.g., bread)
Define "no gains from substitution"
if the marginal rate of substitution is equal to the price ratio, the consumer cannot increase utility by substituting one good for another in the basket, while staying within the budget constraint
Define speculation
investment in stocks, property, or other ventures in the hope of gain but with the risk of loss
Define production in the long run
is a period of time long enough to allow firms to adjust the amount of every input used in production
Define Income effect
is the change in consumption basket associated with a change in income holding prices (and preferences) constant
Define Returns to scale
is the change in output when all inputs into a production process increase (or decrease) in the same proportion.
Define Variable costs
is the cost of inputs that vary with the quantity of the firm's output (e.g.,raw materials)
Define Fixed costs, can they be avoided, if so when?
is the cost of the firm's fixed inputs, independent of the quantity of the firm's output (e.g., office lease). fixed costs that are not sunk cost. They can be avoided if the firm closes down and exits the industry completely
Define Isocost Line
is the line that shows all input combinations that yield the same cost. Since we assume that a firm can buy any amount of labor and capital at market prices, isocost line is a straight line, with the slope equal to relative prices of labor and capital.
Formula for price elasticity of supply is
% change in quantity/ %change in price = delta Q/Q / delta P/ P > 0
Formula for income elasticity
%∆𝑸demanded /%∆𝑰 = ∆𝑸demanded/Q/ ∆𝑰/I
Formula for cross-price elasticity of demand
%∆𝑸demanded of good x / %∆P of good y
Formula for price elasticity of demand is
% change in quantity/ %change in price = delta Q/Q / delta P/ P < 0
What are the 4 assumptions of consumer preferences?
1) Completeness- a consumer can compare any two baskets of goods and decide which one she prefers. Or that she is indifferent between the two. 2)Non-Satiation- more is better than less, or at least not worse than less. 3) Transitivity- if basket 𝑨 is better than 𝑩; and 𝑩 is better than 𝑪; than 𝑨 has to be better than C 4) Preference for variety- the more units a consumer has of a good 𝑿 in her basket, the less she is willing to give up of another good 𝒀 to get an additional unit of X
What are the three different types of returns to scale
1) Constant Returns to Scale: quantity of output increases in the same proportion as inputs 2) Increasing Returns to Scale: quantity of output increases more than inputs 3) Decreasing Returns to Scale: quantity of output increases less than inputs
What are the 9 assumptions about firms producing behavior?
1) Firm produces a single good 2) Firm has already chosen what good to produce 3) Firms minimize costs associated with every level of production 4)Only two inputs are used in production: capital and labor (Capital: buildings, equipment, Labor: various human resources) 5)In the short run, firms can choose the amount of labor employed, but capital is assumed to be fixed 6)Output increases with inputs 7)Inputs are characterized by diminishing returns: if the amount of capital is held constant, each additional worker produces less additional output than the last, and vice versa 8)The firm can buy unlimited capital and labor at fixed prices 9)Capital markets are well functioning: the firm has no budget constraint
What are the 4 assumptions of the basic S&D model?
1) Single market (one good) 2)All goods are identical 3)All units of the good in the market sell at the same price 4) No produces on consumer has influence over the market price
Define Market Supply & Demand
1) Supply- sum of all individual firms willingness to supply an amount of the good 2)Demand- sum of all individuals willingness to buy an amount of the good
Definition of market- 3 characteristics?
1) What is being produced 2) Where is being produced (location) 3)When is it being produced (specific point in time/ interval of time the transaction occurred)
How do marginal value, total value and consumer demand curve relate
A Consumer's Demand Curve Is Her Marginal Value Curve at each price. The demand curve can also help us find the total value by getting the area under the curve
Define Inferior Goods
A good that when income decreases the quantity of that good increases and the opposite is true when income increases. Consumer basket can't only have inferior goods
Define Normal Good
A good that when income increases so does the quantity consumed of that good
Define Price Ceiling
A regulation that sets the maximum price that can be paid for a good or service
Price Floor
A regulation that sets the minimum price that can be paid for a good or service
Define Consumption basket
A set of goods that a consumer consumes over a period of time
Define accounting cost & profit
Accounting cost includes the direct costs (or expenses) of operating a business, including costs of raw materials, etc. Accounting profit is a firm's total revenue minus accounting cost.
Define technological change
An improvement in technology that changes the firm's production function over time in a way that more output is obtained from the same amount of inputs
Define GE analysis
Analysis of how the interrelated markets affect each other and how they reach equilibrium. In many - but not all - cases, GE analysis uncovers effects that are substantially different from effects suggested by partial equilibrium analysis
Define economic cost & profit
Economic cost is the sum of a producer's accounting costs and opportunity costs. Economic profit is a firm's total revenue minus economic cost.
Define Engel Curve
Engel Curve is the relationship between the quantity consumed of one good and a consumer's income holding all prices constant
Define expansion path
Expansion Path is a curve that maps how the optimal mix of inputs varies with total output. This allows construction of the total cost function (curve), that shows a firm's minimum cost of producing particular quantities
What is the income of elasticity or normal and inferior goods?
For normal good: 𝑬𝑰 > 𝟎; for inferior good: 𝑬𝑰 < 𝟎
Graphically where are cost minimized?
Graphically, costs are minimized at the point of tangency between the isoquant associated with the chosen level of production, and the isocost line.
What is the income/Budget Constraint Formula?
I= X x Px + Y x Py
How does lotteries help find an equilibrium in a shortage due to price floors/ceilings. Draw graph for pizza scenario from lecture slides (CS, PS, DWL from lines)
In a lottery, goods gets randomly allocated to all consumers who value it above the price ceiling, not to those who place the highest value on the good and that quantity being supplied. So expected consumer surplus is calculated differently. We calculated by we assuming that the average consumer who wins the lottery has the average valuation of the good. Which is found by taking the (demand choke price- price ceiling/ 2). The DWL is the total surplus with flexible prices minus total surplus with the lottery.
Define "Substitution Effect"
Is the change in the optimal consumption basket in response to new relative price while staying on the same indifference curve
Define Total cost functions
Is the minimum cost of producing a given output as a function of output
Which effect does indifference curve curvature affect and how?
It affects the substitution effect, if the indifference curve is not very "curvy", the two goods are close substitutes and the effect is larger
What is a defining feature of the basket of good?
It can be priced, meaning q1xp1+q2xp2= total price for basket
Define supply function/supply curve
It shows the relationship between price and the quantity that firms are willing to supply at such price.
Define opportunity cost
It's the value of what a producer gives up by using an input
Define Luxury Good
Luxury Good is a (normal) good with income elasticity greater than one: 𝑬𝑰 > 𝟏
What is the formula to find optimal consumption bundle?
MRS= P of good x/P of good y
Define MPL & MPK
Marginal Product of an Input (𝑴𝑷𝑳, 𝑴𝑷𝑲) the additional output that a firm can produce using an additional unit of the input, while holding the other inputs constant
Define MRS
Marginal Rate of Substitution- slope of the indifference curve, which is the rate at which the consumer is willing to trade 𝑿 for 𝒀, and be equally well off: 𝑴𝑹𝑺𝑿𝒀 = MUX/MUY (MRS is always positive number)
Define MRST
Marginal Rate of Technical Substitution 𝑴𝑹𝑻𝑺𝑳𝑲 the rate at which the firm can trade (substitute) input 𝑲 for input 𝑳, holding output constant 𝑴𝑹𝑻𝑺= −𝜟𝑲/𝜟𝑳= 𝑴𝑷𝑳/𝑴𝑷𝑲
Define "Marginal Value Equals Price"
Marginal Utility of Income (𝝀) the amount of utility an additional $𝟏 of income ($𝒑𝒆𝒓𝒖𝒏𝒊𝒕𝒐𝒇𝒕𝒊𝒎𝒆) generates for a consumer: 𝝀 =𝑴𝑼𝑿/𝑷𝑿 = 𝑴𝑼𝒀/𝑷Y Marginal value is obtained if we divide marginal utility of a good by marginal utility of income 𝑴𝑽X= 𝑴𝑼𝑿/λ = 𝑷𝑿 at consumer's optimal point, her marginal benefit from consuming a unit of good 𝑿 (the marginal value of 𝑿) equals her marginal cost of buying a unit of 𝑿 (the price of 𝑿), both measured in dollars
MPK formula
Marginal product of capital is the derivative of the production function with respect to capital: 𝝏𝑭(𝑲, 𝑳)/ 𝝏K
MPL formula
Marginal product of labor is the derivative of the production function with respect to labor: 𝝏𝑭(𝑲, 𝑳)/ 𝝏𝑳
How to consumer theory & Market demand link?
Market demand is the horizontal sum of individual demand curves: the market quantity demanded at each price is the sum of the individual quantities demanded at each price for all consumers in the market
Define Interrelated markets
Markets in which a change in the price, demand, or supply of one good affects a related good (complements & substitutes).
What are the three algebraic intuitions to solve for optimal consumption bundle?
No gains from substitution, equal bang for the buck, marginal value equals price
Does the curvature of the indifference curve tell you if the goods are actually complements or substitutes in the market?
No, these are properties of preferences, not goods themselves: curvature of indifference curves may be different for different consumers; or even for the same consumer at different levels of utility
Define market equilibrium
Occurs when the the quantity of goods supplied is equal to the quantity of goods demanded at a certain price
Define budget constraint and explain the difference between BC & consumer preference?
Preferences are about what we want; budget constraint is about what we can afford. In the two-good case, the budget constraint is 𝑰 = 𝑷𝑿 × 𝑸𝑿 + 𝑷𝒀 × 𝑸𝒀 where 𝑰 is per period consumer's income (measured in $ 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕 𝒐𝒇 𝒕𝒊𝒎𝒆)
Total Effect = ?
Substitution Effect + Income Effect
what factors that influence demand of good?
Tastes and preferences, price of goods, amount of consumers, wealth & income of consumers, price of related goods
What does each the BC & the utility curves tells us about consumer baskets? What do they tell us together?
The BC tells us which baskets are feasible for the consumer to purchase and the utility curves tell us the consumers preferences of those basket. If you combine the two concepts then we start understanding consumer choices.
An inelastic curve will cause what changes to P & Q if there is a shift in another curve.
The change in price will be big but the change in quantity will not
An elastic curve will cause what changes to P & Q if there is a shift in another curve.
The change in price will not be big but the change in quantity will
Define Sunk Costs
The costs that cannot be recovered once spent.
What is the law of the demand?
The demand curve slopes down (as the price decreases the quantity demanded increases)
How does waiting lines help find an equilibrium in a shortage due to price floors/ceilings. Draw graph for pizza scenario from lecture slides (CS, PS, DWL from lines)
The full price of waiting in line is price of good + opportunity cost of time spent in line. When calculating the full price she has to pay for a good, a consumer adds this "time-cost" and the money price. The equilibrium is found by lines getting longer and longer so that the price of the good + the price of waiting in line adds up to the price that matches in the quantity supplied of the good. Time spend in line is DWL, so the cost of waiting lines becomes the DWL
What does a straight line indifference curve tell you?
The goods are easily substitutable with one another
What does an "L" shape/more convex indifference curve tell you?
The goods are perfect complements to each other
Are you indifferent about the different baskets within a indifference curve?
Yes, ∆𝑸𝒕−𝒔𝒉𝒊𝒓𝒕𝒔/∆𝑸𝒔𝒐𝒄𝒌𝒔 = 𝑴𝑼𝒔𝒐𝒄𝒌𝒔/𝑴𝑼𝒕−𝒔𝒉𝒊𝒓𝒕𝒔
Define Utility function of a consumer
a function that assigns a preference value to each basket, which allows consumer to compare her options based on preferences. The consumer numbers each consumption basket in a way that if consumer prefers basket 𝑨 to basket 𝑩, then 𝑼(𝑨) >𝑼(𝑩); and if she is indifferent between baskets 𝑪 and 𝑫, then 𝑼 𝑪 = 𝑼(𝑫)
Quotas
a government regulation that sets a limit on the quantity of a good or service provided in a market
Define Flow variable
a physical unit of good per unit of time
Define indifference curves
a plot of all consumption baskets that provide a consumer with the same level of utility. Used to understand consumption trade-offs: how consumers are willing to sacrifice a certain amount of one good to get an amount of another good
How does speculation help find an equilibrium in a shortage due to price floors/ceilings. Draw graph for pizza scenario from lecture slides (show CS and speculator surplus, and PS)
speculators buy all the goods that are produced and sell it in the blackmarket at higher price, usually prices where the consumers were willing to pay at that quantity of the good. The good is allocated to only those consumers who value the good at the highest price (price that matches the the quantity supplied if there were no restrictions)
Define Demand Function
the curve that shows the relationship between price and consumers quantity demanded
Define producer surplus
the difference between the dollar amount producers are willing to produce a good for and the market price for that good
Define consumer surplus
the difference between the dollar amount that a consumer is willing to pay for a good and the market price of the good
Define equilibrium price
the price at which consumers are willing to buy the same aggregate quantity of the good that the suppliers are willing to sell