Microeconomics - MIDTERM

What does behavioral economics have to say about each of the following statements? a. "Nobody is truly charitable-they just give money to show off." b. "America has a ruthless capitalist system. Considerations of fairness are totally ignored." c. "Selfish people always get ahead. It's like nobody even notices!"

a. Behavior economics would say that people often act in their own self-interests; however, not exclusively. Economic transactions are heavily influenced by moral and ethical factors. b. Behavioral economics has studied moral and ethical factors that affect economic behavior and fairness is among the most important. There is both field and experimental evidence that fairness has a strong effect on people's behavior. Examples: giving to charity, obeying the law, and the outcomes of experimental games. c. Experiments have shown that people are not exclusively selfish, and when people are treated unfairly, they react very strongly.

As it relates to corporations, the principal-agent problem is that:

the goals of the corporate managers (the agents) may not match the goals of the corporate owners (the principals).

Evaluate and explain the following statements: a. The market system is a profit-and-loss system. b. Competition is the disciplinarian of the market economy.

(a) The quotation is accurate. In a market system, producer decisions are motivated by the attempt to earn profits. Because profits and/or losses are the motivation behind the fundamental decisions made in a market system, it could be called a "profit and loss economy." (b) Competition provides discipline in two ways. First, it forces firms to seek the least-cost production methods or face being driven out of business by their rivals. Second, it prevents successful producers from charging whatever the market will bear. Where competition does not exist, such as in natural monopolies like public utility companies, regulators or publicly owned companies must assume the role of disciplinarian. Experience has shown that this is a difficult process and does not achieve the same results as easily as a competitive market situation.

State (a) a positive economic statement of your choice, and then (b) a normative economic statement relating to your first statement.

(a) The unemployment rate is 4.8 percent; (b) the unemployment rate is too high.

What divergences arise between equilibrium output and efficient output when (a) negative externalities and (b) positive externalities are present?

(a) When negative externalities are present, the equilibrium output will be greater than the efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level, which would exist if true costs were reflected in the production decision. (b) When positive externalities are present, the equilibrium output will be smaller than the efficient output because the consumer is willing to pay a price equal to the consumer's individual marginal benefit, but no more.

Contrast how a market system and a command economy try to cope with economic scarcity.

A market system allows for the private ownership of resources and coordinates economic activity through market prices. Participants act in their own self interest and seek to maximize satisfaction or profit through their own decisions regarding consumption or production. Goods and services are produced and resources are supplied by whoever is willing to do so. The result is competition and widely dispersed economic power. The command economy is characterized by public ownership of nearly all property resources and economic decisions are made through central planning. The planning board, appointed by the government determines production goals for each enterprise. The division of output between capital and consumer goods is centrally decided based on the board's long-term priorities

The income elasticities of demand for movies, dental services, and clothing have been estimated to be +3.4, +1, and +.5, respectively. Interpret these coefficients. What does it mean if an income elasticity coefficient is negative?

All are normal goods—income and quantity demanded move in the same direction. These coefficients reveal that a 1 percent increase in income will increase the quantity of movies demanded by 3.4 percent, of dental services by 1 percent, and of clothing by 0.5 percent. A negative coefficient indicates an inferior good—income and quantity demanded move in the opposite direction.

What is an opportunity cost? How does the idea relate to the definition of economics?

An opportunity cost is what was sacrificed to do or acquire something else. The condition of scarcity creates opportunity cost. If there was no scarcity, there would be no need to sacrifice one thing to acquire another.

Why do behavioral economists consider it helpful to base a theory of economic behavior on the actual mental processes that people use to make decisions? Why do neoclassical economists not care about whether a theory incorporates those actual mental processes?

Behavioral economists do consider it helpful to base economic theories about behavior on the actual mental processes that people use to make decisions. Neoclassical economists do not care about whether a theory incorporates the actual mental processes used to make decisions because they only care about whether a theory makes accurate predictions about observed behavior.

What is meant by the term "creative destruction"? How does the emergence of MP3 (or iPod) technology relate to this idea?

Creative destruction refers to the process by which the creation of new products and production techniques destroys the market positions of firms committed to producing only existing products or using outdated methods. The ability to download and store a large number of songs, and the superior quality of MP3 is causing a decline in the CD industry, just as CDs once replaced cassette tapes, which had previously replaced phonographs (records).

What are economic resources? What categories do economists use to classify them? Why are resources also called factors of production? Why are they called inputs?

Economic resources are the natural, human, and manufactured inputs used to produce goods and services. Economic resources fall into four main categories: labor, land (natural resources), real capital (machines, factories, buildings, etc.,) and entrepreneurs. Economic resources are also called factors of production because they are used to produce goods and services. They are called inputs because they go in to a production process (like ingredients go into a bowl to make a cake), with the resulting goods and services also being referred to as output.

Rank each of the following three gift possibilities in terms of how much utility they are likely to bring and explain your reasoning.  A store-specific gift card worth $15, a $15 item from that specific store, and $15 of cash that can be spent anywhere.

From the highest to lowest likely utility, we would rank the options as follows: Cash, gift card, specific item.

Critique: "Thank goodness we have so many government regulatory agencies. They keep Big Business in check."

Government regulatory agencies sometimes fall under the sway of the industries that they are supposed to be regulating. Those instances of "regulatory capture" imply that this statement is overly confident in the ability of government regulatory agencies to keep powerful businesses in check.

Suppose that Ike is loss averse. In the morning, Ike's stockbroker calls to tell him that he has gained $1,000 on his stock portfolio. In the evening, his accountant calls to tell him that he owes an extra $1,000 in taxes. At the end of the day, does Ike feel emotionally neutral since the dollar value of the gain in his stock portfolio exactly offsets the amount of extra taxes he has to pay? Explain.

If Ike is loss averse he will feel losses more intensely than gains. This implies that the increase in taxes of $1,000 will cause a greater level of disutility than the gain in utility Ike derives from the $1,000 increase in his stock portfolio. In effect, because Ike is loss averse, he worse off in terms of utility. If we use the intensity figure from the textbook, the $1,000 loss is felt 2.5 more intensely than the $1,000 gain.

Research has found that an increase in the price of beer would reduce the amount of marijuana consumed. Is cross elasticity of demand between the two products positive or negative? Are these products substitutes or complements? What might be the logic behind this relationship?

If the cross elasticity is negative, this implies that an increase in the price of one good results in a decrease in the quantity purchased of another good. This implies that the goods are compliments; as the price of one good increases, it reduces the consumption of other goods (purchased less). The cross elasticity of the two products above is negative. Thus, the products appear to be complementary. As one drinks beer, one also smokes marijuana.

The LoJack car recovery system allows the police to track stolen cars. As a result, they not only recover 90% of LoJack-equipped cars that are stolen but also arrest many auto thieves and shut down many "chop shops" that take apart stolen vehicles to get at their used parts. Thus, LoJack provides both private benefits and positive externalities. Should the government consider subsidizing LoJack purchases?

If the government were to subsidize LoJack purchases, this would reduce the private cost of the anti-theft devices. This reduction in the private cost would, in-turn, increase the purchase of the LoJack system. Yes, the government should consider subsidizing LoJack purchases.

How does the problem of limited and bundled choice in the public sector relate to economic efficiency? Why are public bureaucracies possibly less efficient than firms?

Limited and bundled choice in the political process tends to reduce economic efficiency because blocks of public goods and social programs are provided. The private market is driven by profit. If a company continues to lose money or produces a good that society does not want it goes out of business. If the public sector, a bureaucracy, fails to use its resources efficiently then the market is not there to discipline it.

In a sentence, describe the meaning of the phrase "invisible hand."

Market prices act as an "invisible hand," coordinating an economy by rationing what is scarce and providing incentives to produce the most desired goods and services.

Which of the following is a distinguishing feature of laissez-faire capitalism?

Minimal government intervention.

Which of the following best explains the difference between neoclassical economics and behavioral economics?

Neoclassical economics assumes that people are rational in their decision making, while behavioral economics believes people make systematic errors.

What do neoclassical economics and behavioral economics believe about giving people options?

Neoclassical economics focuses on providing more options; behavioral economics focuses on helping people make better decisions with the options available.

What is rent seeking and how does it differ from the kinds of profit maximization and profit seeking that we discussed in previous chapters? Why do elected officials often accommodate rent-seeking behavior, particularly by firms, unions, and professional groups located in their home states?

Rent-seeking is an appeal to the government for special benefits at taxpayers or someone else's expense. The term 'rent' refers to any payment is excess of the minimum amount that is necessary to keep the resource employed in its current use. Rent-seeking is different from profit maximization because rent-seeking attempts to influence the political process to gain increased profit or income. These groups tend to be politically more active and willing to spend resources supporting individuals who support their respective objectives. Thus, a politician is likely to support their activities.

Suppose that, on the basis of a nation's production possibilities curve, an economy must sacrifice 10,000 pizzas domestically to get the 1 additional industrial robot it desires but that it can get the robot from another country in exchange for 9,000 pizzas. Relate this information to the following statement: "Through international specialization and trade, a nation can reduce its opportunity cost of obtaining goods and thus 'move outside its production possibilities curve.'"

The message of the production possibilities curve is that an individual nation is limited to the combinations of output indicated by its production possibilities curve. International specialization means directing domestic resources to output which a nation is highly efficient at producing. International trade involves the exchange of these goods for goods produced abroad. Specialization and trade have the same effect as having more and better resources or discovering improved production techniques. The output gains from greater international specialization and trade are the equivalent of economic growth.

What are the determinants of supply? What happens to the supply curve when any of these determinants changes?

The non-price determinants of supply are: resource (input) prices, technology, taxes and subsidies, prices of other related goods, expectations, and the number of sellers. These determinants will cause a shift in the supply curve. Anything causing an increase in supply will shift the supply curve to the right. A decrease in supply will be shown by a shift to the left.

Why is private property, and the protection of property rights, so critical to the success of the market system? How do property rights encourage cooperation?

The ownership of private property and the protection of property rights encourages investment, innovation, and, therefore, economic growth. Property rights encourage the maintaining of the property and they facilitate the exchange of the property. However, the most important consequence of property rights is that they encourage people to cooperate by helping to ensure that only mutually agreeable economic transactions take place.

Distinguish between the resource market and the product market in the circular flow model. In what way are businesses and households both sellers and buyers in this model? What are the flows in the circular flow model?

The resource markets are where the owners of the resources (the households) sell their resources to the buyers of the resources (businesses). In the product markets, businesses sell the goods and services they have produced to the buyers of the goods and services, the households. These households are willing to sell their resources to businesses because attractive prices draw them into specific resource markets. Businesses buy resources because they are necessary for producing goods and services. In the product market, businesses are the sellers and householders are the buyers; their role in the market has been reversed. Each group of economic units both buys and sells.

What effect would a rule stating that university students must live in university dormitories have on the price elasticity of demand for dormitory space? What impact might this in turn have on room rates?

The ruling would make the price elasticity of demand more inelastic than if there were no such rule, assuming that there is not another equivalent university nearby to which students could transfer. Although universities are nonprofit organizations, the rule would certainly allow them to raise rates without worrying so much about students moving out to live elsewhere.

In 2001 an outbreak of foot-and-mouth disease in Europe led to the burning of millions of cattle carcasses. What impact do you think this had on the supply of cattle hides, hide prices, the supply of leather goods, and the price of leather goods?

The supply of cattle hides was reduced, raising the price of hides. Because hides were more expensive, it became more costly to produce leather, reducing the supply and raising the price of leather goods

Microeconomics is concerned with:

a detailed examination of specific economic units that make up the economic system.

What are the determinants of demand? What happens to the demand curve when any of these determinants change?

There are determinants of demand, which are factors that may shift the demand curve, or cause a "change in demand." These are the number of buyers, the tastes (or desires) of the buyers, the income of the buyers, the changes in price of related commodities (substitutes and complements), and expectations of the buyers regarding the future price of the commodity under discussion. The determinants of demand will cause a shift in the demand curve. If it is something that increases the demand, the curve will shift to the right. A decrease in demand will be shown by a shift to the left. This is representative of quantity demanded changing at every price, either increasing or decreasing.

In the last decade or so there has been a dramatic expansion of small retail convenience stores (such as 7 Eleven, Kwik Shop, and Circle K), although their prices are generally much higher than prices in large supermarkets. What explains the success of the convenience stores?

These stores are selling convenience as well as the goods that are purchased there. Because of their small size and convenient locations, they save busy consumers time.

How can time be incorporated into the theory of consumer behavior? Explain the following comment: "Want to make millions of dollars? Devise a product that saves Americans lots of time."

Time is money. This expression is a time saving way of making the point that for a person who can make so much per hour, every hour spent not working is so much money not made

An apple grower's orchard provides nectar to a neighbor's bees, while the beekeeper's bees help the apple grower by pollinating his apple blossoms. Use Figure 4.6b to explain why this situation of dual positive externalities might lead to an underallocation of resources to both apple growing and beekeeping. How might this underallocation get resolved via the means suggested by the Coase theorem?

Using the Coase theorem, we note that it will be to the advantage of individual apple growers and beekeepers to negotiate so that beekeepers (whose hives can be moved) locate their production in or near orchards. This negotiation will occur as long as property ownership is well defined, only a few people are involved, and bargaining costs are low.

Discuss the political incentives that helped motivate federal politicians to approve budget deficits in all but five years between 1960 and 2015.

Voters like the benefits of increased government spending, but do not like having to pay the taxes necessary to fund all the costly government programs that they like. So, politicians have a political incentive to support high levels of spending by only moderate levels of taxation. A common result is budget deficits, as those political tendencies promote situations in which spending exceeds tax revenues. To bridge the gap, governments borrow money, usually by selling bonds

What do economists mean when they say "price floors and ceilings stifle the rationing function of prices and distort resource allocation"?

When unrestrained, prices rise and fall to correct imbalances between the quantity supplied and quantity demanded in a market. If sellers find themselves at a given price with more output than consumers are willing to purchase, they will lower the price. Likewise, if the market is not offering enough of a good to satisfy consumer demand, the price will rise.

Economist Gerd Gigerenzer characterizes heuristics as "fast and frugal" ways of reaching decisions. Are there any costs to heuristics being "fast and frugal"? Explain and give an example of how a fast and frugal method for doing something in everyday life comes at some costs in terms of other attributes forgone.

While heuristics are fast and frugal, they are not perfect. In particular, they achieve high speed and low energy use at the cost of precision and accuracy. As an example of how a fast and frugal method for doing something comes at some cost in terms of other attributes forgone, consider a bartender checking ID's.

Explain why zoning laws, which allow certain land uses only in specific locations, might be justified in dealing with a problem of negative externalities. Explain why in areas where buildings sit close together tax breaks to property owners for installing extra fire prevention equipment might be justified in view of positive externalities. Explain why excise taxes on beer might be justified in dealing with a problem of external costs

Zoning could force businesses producing negative externalities to locate in regions where these costs would not spill over onto third parties, or where such costs would at least be reduced Tax breaks to property owners who install fire prevention equipment reduces the potential of fire spreading to nearby buildings. Thus, the fire prevention equipment will have positive externalities because of the additional benefit to the community. The over-consumption of beer can cause negative externalities. An excise tax can be used to discourage supply of beer, by making it less profitable to suppliers since they have to give more back to the government, this would shift the supply curve to the left.

Jennifer buys a piece of costume jewelry for $33, for which she was willing to pay $42. The minimum acceptable price to the seller, Nathan, was $30. Jennifer experiences

a consumer surplus of $9, and Nathan experiences a producer surplus of $3.

A recent study found that an increase in the federal tax on beer (which would increase the price of beer) would reduce the demand for marijuana. Based on this information we can conclude that

beer and marijuana are complementary goods.

Suppose Aiyanna's Pizzeria currently faces a linear demand curve and is charging a very high price per pizza and doing very little business. Aiyanna now decides to lower pizza prices by 5 percent per week for an indefinite period of time. We can expect that each successive week:

demand will become more price elastic.

People enjoy outdoor holiday lighting displays and would be willing to pay to see these displays but can't be made to pay. Because those who put up lights are unable to charge others to view them, they don't put up as many lights as people would like. This is an example of a

demand-side market failure.

The relationship between quantity supplied and price is ________, and the relationship between quantity demanded and price is ________.

direct; inverse

As it relates to the political process, the principal-agent problem results from the:

inconsistency between voters' interest in programs and politicians' interest in reelection.

Mary says, "You would have to pay me $50 to attend that pro wrestling event." For Mary, the marginal utility of the event is:

negative.

Cite three examples of recent decisions that you made in which you, at least implicitly, weighed marginal cost and marginal benefit

to skip breakfast to get a few extra minutes of sleep, to attend college, or to make a purchase. Marginal benefits of attending class may include the acquisition of knowledge, participation in discussion, and better preparation for an upcoming examination.