EC 201 Final Exam Amsler

Around 1973, the U.S. economy experienced a significant ________ in productivity growth, coupled with a(n) ________ in the growth of real wages.

slowdown, slowdown

If the price of pasta increases and a consumer buys more pasta, we can infer that...

...pasta is an inferior good, and the income effect is greater than the substitution effect.

Which of the following conditions does NOT describe a firm in a monopolistically competitive market? 1. It makes a product different from its competitors. 2. It takes its price as given by market conditions. 3. It maximizes profit both in the short run and in the long run. 4. It has the freedom to enter or exit in the long run.

# 2

Which of the following is a positive, rather than a normative, statement? 1. Law X will reduce national income. 2. Law X is a good piece of legislation. 3. Congress ought to pass law X. 4. The President should veto law X.

#1 Positive statements are descriptive; they make a claim about how the world is. However, normative statements are prescriptive; they make a claim about how the world ought to be. Therefore, in this case, the only positive statement is Law X will reduce national income because it states what will happen if something is done rather than what should be done.

Which of the following statements about corrective taxes is not true? 1. Economists prefer them to command-and-control regulation. 2. They raise government revenue. 3. They cause deadweight losses. 4. They reduce the quantity sold in a market.

#3

Which of the following is an example of a positive externality? 1. Bob mows Hillary's lawn and is paid $100 for performing the service. 2. While mowing the lawn, Bob's lawnmower spews out smoke that Hillary's neighbor Kristen has to breathe. 3. Hillary's newly cut lawn makes her neighborhood more attractive. 4. Hillary's neighbors pay her if she promises to get her lawn cut on a regular basis.

#3 A positive externality arises when a person engages in an activity that influences the well-being of a bystander in a beneficial way but that person neither pays nor receives any compensation for that effect. In this case, Hillary having her lawn mowed positively benefits her neighbors by beautifying the neighborhood.

All of the following topics fall within the study of microeconomics EXCEPT 1. the impact of cigarette taxes on the smoking behavior of teenagers. 2. the role of Microsoft's market power in the pricing of software. 3. the effectiveness of antipoverty programs in reducing homelessness. 4. the influence of the government budget deficit on economic growth.

#4 Microeconomics is the study of how households and firms make decisions and how they interact in specific markets. Macroeconomics is the study of economy-wide phenomena. Therefore, the influence of the government budget deficit on economic growth is a macroeconomic topic, while the others are all microeconomic topics.

Jane pays Chuck $50 to mow her lawn every week. When the government levies a mowing tax of $10 on Chuck, he raises his price to $60. Jane continues to hire him at the higher price. What is the change in producer surplus, change in consumer surplus, and deadweight loss?

$0, -$10, $0

Two political candidates are vying for town mayor, and the key issue is how much to spend on the annual Fourth of July fireworks. Among the 100 voters, 40 voters want to spend $30,000, 30 voters want to spend $10,000, and 30 voters want to spend nothing at all. What is the winning position on this issue?

$10,000 based on median voter theorem

Andy gives piano lessons. He has an opportunity cost of $50 per lesson and charges $60. He has two students: Bob, who has a willingness to pay of $70, and Carl, who has a willingness to pay of $90. When the government puts a $20 tax on piano lessons and Andy raises his price to $80, the deadweight loss is _____ and the tax revenue is _____.

$20, $20

The government auctions off 500 units of pollution rights. They sell for $50 per unit, raising total revenue of $25,000. This policy is equivalent to a corrective tax of _____ per unit of pollution.

$50

Raj opens up a lemonade stand for two hours. He spends $10 for ingredients and sells $60 worth of lemonade. In the same two hours, he could have mowed his neighbor's lawn for $40. Raj has an accounting profit of _____ and an economic profit of ____.

$50, $10 An accountant measures the firm's accounting profit as the firm's total revenue minus only the firm's explicit costs. In this example, revenue is equal to the $60 from selling lemonade, and explicit costs are the $10 in ingredients; therefore, accounting profit is $60-$10 = $50. An economist measures a firm's economic profit as the firm's total revenue minus all the opportunity costs (explicit and implicit) of producing the goods and services sold. The $40 Raj could have earned mowing his neighbor's lawn is an opportunity cost. Economic profit takes this cost into consideration as well and is only $60-$10-$40 = $10.

An economic model is...

...a simplified representation of some aspect of the economy. Because including every detailed, realistic aspect of an economy would result in something that isn't tractable and informative, economists use models to learn about the world. Just as a model airplane does not include all of the interior details of the plane, an economist's model does not include every feature of the economy.

A point inside the production possibilities frontier is...

...feasible, but not efficient.

The circular-flow diagram illustrates that, in markets for the factors of production...

...households are sellers, and firms are buyers. The circular-flow diagram simplifies the economy by including only two types of decision makers: firms and households. Firms produce goods and services using inputs, such as labor, land, and capital. These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce. Therefore, in the markets for the factors of production, households are sellers, and firms are buyers.

Economics is best defined as the study of...

...how society manages its scarce resources. This includes studying how people make decisions and interact with one another, and the effects this has on the economy as a whole.

A marginal change is one that...

...incrementally alters an existing plan. Economists use the term marginal change to describe a small incremental adjustment to an existing plan of action. Recall that margin means "edge," so marginal changes are alterations around the edges of what you are doing.

An economy produces hot dogs and hamburgers. If a discovery of the remarkable health benefits of hot dogs were to change consumers' preferences, it would...

...move the economy along the production possibilities frontier.

Governments may intervene in a market economy in order to...

...protect property rights, correct a market failure due to externalities, & achieve a more equal distribution of income. One reason we need government is that the invisible hand relies on the enforcement of property rights so individuals can own and control scarce resources. In addition, although the invisible hand can often guide market participants to a desirable market outcome, sometimes government intervention is necessary to correct for market failures. This term refers to a situation in which the market on its own will fail to produce an efficient allocation of resources. One example of a market failure is an externality; this occurs when one person's action inadvertently affects another person's well-being. Finally, the efficient outcome attained by the invisible hand doesn't necessarily result in equality among its participants. Depending on your political philosophy, this disparity in economic well-being may lead you to believe that government intervention is necessary.

Adam Smith's phrase "invisible hand" refers to...

...the ability of free markets to reach desirable outcomes, despite the self-interest of market participants. In his 1776 book, economist Adam Smith acknowledged that households and firms act as if they are guided by an "invisible hand" that leads to a desirable market outcome. Although participants in the market act with their own self-interest in mind (for example, households seek to maximize their happiness while firms seek to maximize profits), free markets can reach desirable outcomes without additional intervention under certain assumptions and market conditions.

If a nation has high and persistent inflation, the most likely explanation is...

...the central bank creating excessive amounts of money. The usual suspect in cases of large or persistent inflation is growth in the quantity of money. When a government's central bank creates large quantities of money, the value of that money falls, causing prices to rise and resulting in inflation.

The labor supply curve slopes upward if...

...the substitution effect on leisure is greater than the income effect.

Your opportunity cost of going to a movie is...

...the total cash expenditure needed to go to the movie plus the value of your time. The opportunity cost of an item is what you give up to get that item. In this case, the opportunity cost of going to a movie includes both the total cash expenditure needed to go to the movie and the value of the time you gave up in order to watch the movie.

At any point on an indifference curve, the slope of the curve measures the consumer's...

...willingness to trade one good for the other. The slope at any point on an indifference curve equals the rate at which the consumer is willing to substitute one good for the other. This rate is called the marginal rate of substitution.

The price of a good rises from $8 to $12, and the quantity demanded falls from 110 to 90 units. Calculated with the midpoint method, the elasticity is:

1/2 PEC = % change in Q demanded / % change in P

A bakery operating in competitive markets sells its output for $20 per cake and hires labor at $10 per hour. To maximize profits, it should hire labor until the marginal product of labor is

1/2 cake per hour.

If the tax code exempts the first $20,000 of income from taxation and then taxes 25 percent of all income above that level, then a person who earns $50,000 has an average tax rate of _____ percent and a marginal tax rate of _____ percent.

15, 25

Matthew and Susan are both optimizing consumers in the markets for shirts and hats, where they pay $100 for a shirt and $50 for a hat. Matthew buys 4 shirts and 16 hats, while Susan buys 6 shirts and 12 hats. From this information, we can infer that Matthew's marginal rate of substitution is _____ hats per shirt, while Susan's is _____.

2, 2 To consume optimally, the consumer chooses consumption of the two goods so that the marginal rate of substitution equals the relative price. The relative price is determined by the rate at which the market is willing to exchange the goods for one another; that is, because a shirt costs 2 times as much as a hat, the market exchanges 2 hats per shirt. Both Matthew and Susan will, therefore, consume hats and shirts up to the point where their respective marginal rates of substitution are equal to 2 hats per shirt.

A change in which of the following will not shift the demand curve for hamburgers? 1. The price of hot dogs 2. The price of hamburgers 3. The price of hamburger buns 4. The income of hamburger consumers

2. The price of hamburgers if the price of hamburgers changes, the result is a movement along the demand curve from the old price to the new one. However, if a change occurs in any of the factors that determine demand—such as the price of hot dogs (a substitute), the price of hamburger buns (a complement), or the income of hamburger consumers—the result is a shift of the demand curve.

In the United States, taxpayers in the top one percent of the income distribution pay about _____ percent of their income in federal taxes.

30

In the United States, the poorest fifth of the population earns about _____ percent of all income, while the richest fifth earns about _____ percent.

4, 45

Approximately what percentage of U.S. national income is paid to workers, as opposed to owners of capital and land?

70%

Which of the following might lead to an increase in the equilibrium price of jelly and a decrease in the equilibrium quantity of jelly sold?

An increase in the price of grapes, an input to jelly

product differentiation

A key feature of monopolistic competition. That is, each firm produces a product that is at least slightly different from those of other firms. The market for soft drinks is characterized by product differentiation, whereas the markets for wheat, tap water, and crude oil are not.

Coase thm

According to the Coase theorem, if private parties can bargain over the allocation of resources at no cost, then the private market will always solve the problem of externalities and allocate resources efficiently. Therefore, the Coase theorem does not apply if transaction costs make negotiating difficult.

The government imposes a $1,000 per year license fee on all pizza restaurants. Which cost curves shift as a result?

Average total cost and average fixed cost. A license fee is an example of a fixed cost; that is, it does not vary with the level of output. Both average total cost and average fixed cost include fixed costs in their calculations. Therefore, the license fee would cause both of these curves to shift.

A firm is producing 20 units with an average total cost of $25 and marginal cost of $15. If the firm were to increase production to 21 units, which of the following must occur?

Average total cost would decrease. Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising. In this case, marginal cost is below average total cost, therefore, average total cost is falling and would decrease if the firm were to increase production to 21 units.

inferior good

If the demand for a good rises when income falls, the good is called an inferior good. An increase in demand results in a rise in both the equilibrium price and quantity of a good

Suppose that in the United States, producing an aircraft takes 10,000 hours of labor and producing a shirt takes 2 hours of labor. In China, producing an aircraft takes 40,000 hours of labor, while producing a shirt takes 4 hours of labor. What will these nations trade?

China will export shirts, while the United States will export aircraft.

For a profit-maximizing monopoly that charges the same price to all consumers, what is the relationship between price (P), marginal revenue (MR), and marginal cost (MC)?

P>MR, MR = MC

When the nation of Ectenia opens itself to world trade in coffee beans, the domestic price of coffee beans falls. Which of the following describes the situation?

Domestic production of coffee falls, and Ectenia becomes a coffee importer.

absolute advantage

Economists use the term absolute advantage when comparing the productivity of one person, firm, or nation to that of another. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. In this case, Ron can wash a car in less time than it takes David, so he has an absolute advantage in washing, but it takes both of them the same amount of time to mow 1 lawn, so neither has an absolute advantage in mowing.

comparative advantage

Economists use the term comparative advantage when describing the opportunity costs faced by of two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. In this case, David's opportunity cost of washing a car is 1/2 mowed lawns, while Ron's opportunity cost of washing a car is 1/3 mowed lawns. Therefore, Ron has a comparative advantage in washing cars. Similarly, David's opportunity cost of mowing a lawn is 2 washed cars, while Ron's opportunity cost of mowing a lawn is 3 washed cars. Therefore, David has a comparative advantage in mowing lawns.

Which of the following is an example of a common resource? Residential housing National defense Restaurant meals Fish in the ocean

Fish in the ocean

long run vs. short run

In the short-run, a firm chooses to shut down if the price of the good is less than the average variable cost of production. This is because if the price a firm receives for a good doesn't cover the average variable cost of producing it, the firm is better off stopping production altogether. Because a competitive firm sets price equal to marginal cost, and marginal cost is greater than average variable cost, price must be greater than average variable cost; so the firm continues to produce in the short run. In the long run, if the price is less than the average total cost (as is the case in this example), the firm chooses to exit (or not enter) the market.

The demand curve for cookies is downward sloping. When the price of cookies is $2, the quantity demanded is 100. If the price rises to $3, what happens to consumer surplus?

It falls by less than $100.

What is true of a monopolistically competitive market in long-run equilibrium?

Price is greater than marginal cost.

If the economy goes into a recession and incomes fall, what happens in the markets for inferior goods?

Prices and quantities both rise.

Which categories of goods are rival in consumption?

Private goods and common resources

A firm is producing 1,000 units at a total cost of $5,000. If it were to increase production to 1,001 units, its total cost would rise to $5,008. What does this information tell you about the firm?

Marginal cost is $8, and average total cost is $5. Marginal cost tells us the increase in total cost that arises from producing an additional unit of output. In this case, producing one additional unit raises costs by $5008 - $5000 = $8. Average total cost tells us the cost of a typical unit of output if total cost is divided evenly over all the units produced. In this case, total cost divided by the number of units produced is equal to roughly $5008/1001 = $5.

Which of the following is an example of a public good? Residential housing National defense Restaurant meals Fish in the ocean

National defense

condorcet paradox

Normally, we expect preferences to exhibit a property called transitivity: If A is preferred to B, and B is preferred to C, then we would expect A to be preferred to C. The Condorcet paradox is that democratic outcomes do not always obey this property. Pairwise voting might produce transitive preferences for society in some cases, but it cannot be counted on to do so.

In the long-run equilibrium of a competitive market with identical firms, what is the relationship between price (P), marginal cost (MC), and average total cost (ATC)?

P = MC, and P = ATC

free rider problem

Public goods are neither excludable nor rival in consumption. Because public goods are not excludable, the free-rider problem prevents the private market from supplying them. A free rider is a person who receives the benefit of a good but does not pay for it. The government, however, can potentially remedy the free-rider problem by providing the public good, paying for it with tax revenue, and making everyone better off.

Once again, in an hour, David can wash 2 cars or mow 1 lawn, while Ron can wash 3 cars or mow 1 lawn. Who has the comparative advantage in car washing, and who has the comparative advantage in lawn mowing?

Ron in washing, David in mowing.

In an hour, David can wash 2 cars or mow 1 lawn, while Ron can wash 3 cars or mow 1 lawn. Who has the absolute advantage in car washing, and who has the absolute advantage in lawn mowing?

Ron in washing, neither in mowing.

Which of the following trade policies would benefit producers, hurt consumers, and increase the amount of trade?

Starting to allow trade when the world price is greater than the domestic price

Movie tickets and DVDs are substitutes. If the price of DVDs increases, what happens in the market for movie tickets?

The demand curve shifts to the right.

income effect and substitution effect

The impact of a change in price of a good on consumption can be decomposed into two effects: an income effect and a substitution effect. When the price of milk rises, the following responses capture the meaning of the income effect and substitution effect: Income Effect: Now that milk is more expensive, Charlie's income has less purchasing power. Because milk is a normal good, this leads Charlie to purchase less milk. Because cereal is an inferior good, this leads Charlie to purchase more cereal. Substitution Effect: Now that the price of milk has risen, Charlie gets less milk for every box of cereal he gives up. Because cereal is now relatively less expensive, Charlie should buy more cereal and less milk. Therefore, when milk is a normal good, cereal is an inferior good, and the price of milk rises, Charlie will buy less milk and more cereal according to both effects.

What would increase quantity supplied, decrease quantity demanded, and increase the price that consumers pay?

The imposition of a binding price floor

Emilio buys pizza for $10 and soda for $2. He has income of $100. His budget constraint will experience a parallel outward shift if which of the following events occurs?

The price of pizza rises to $20, the price of soda rises to $4, and his income rises to $400.

What would increase quantity supplied, increase quantity demanded, and decrease the price that consumers pay?

The repeal of a tax levied on producers

supply & demand

The term demand refers to the position of the demand curve, whereas the term quantity demanded refers to the amount consumers wish to buy. Similarly, the term supply refers to the position of the supply curve, whereas the term quantity supplied refers to the amount suppliers wish to sell. In this case, an increase in supply will cause the equilibrium price to decrease, resulting in a movement along the demand curve. The demand curve itself remains unchanged, but the quantity demanded is affected.

Mark can cook dinner in 30 minutes and wash the laundry in 20 minutes. His roommate takes half as long to do each task. How should the roommates allocate the work?

There are no gains from trade in this situation. Economists use the term comparative advantage when describing the opportunity costs faced by of two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. In this case, Mark gives up 3/2 loads of laundry when he cooks dinner, but his roommate faces the same opportunity cost. Similarly Mark gives up 2/3 dinners when he does the laundry, but again his roommate faces the same opportunity cost. Therefore, there are no gains from trade in this situation because neither individual has a comparative advantage in either activity.

A storm destroys several factories, thereby reducing the stock of capital. What effect does this event have on factor markets?

Wages fall, and the rental price of capital rises.

substitutes: shift in demand curve

When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. If movie tickets and DVDs are substitutes and the price of DVDs increases, this means the demand for movie tickets will also increase. This results in the demand curve shifting to the right.

how do wages affect labor supply?

When wages rise, leisure becomes more costly relative to consumption, and this encourages people to substitute away from leisure and toward consumption. In other words, the substitution effect induces people to work harder in response to higher wages, which tends to make the labor-supply curve slope upward. At the same time, rising wages move people to higher indifference curves. As long as consumption and leisure are both normal goods, people tend to want to use this increase in well-being to enjoy both higher consumption and greater leisure. In other words, the income effect induces people to consume more leisure (and work less), which tends to make the labor-supply curve slope backward. Thus, the labor-supply curve slopes upward only when the substitution effect on leisure is greater than the income effect.

A $1 per unit tax levied on consumers of a good is equivalent to

a $1 per unit tax levied on producers of the good.

Lucy and Ethel work at a local department store. Lucy, who greets customers as they arrive, is paid less than Ethel, who cleans the bathrooms. This is an example of

a compensating differential

Compared to the social optimum, a monopoly firm chooses

a quantity that is too low and a price that is too high.

A life-saving medicine without any close substitutes will tend to have:

a small elasticity of demand

The key feature of an oligopolistic market is that

a small number of firms are acting strategically.

When the government imposes a binding price floor, it causes

a surplus of the good to develop.

If a policymaker wants to raise revenue by taxing goods while minimizing the deadweight losses, he should look for goods with ________ elasticities of demand and ________ elasticities of supply.

small, small

If the production of a good yields a negative externality, then the social-cost curve lies ________ the supply curve, and the socially optimal quantity is ________ than the equilibrium quantity.

above, less

Because Elaine has a family history of significant medical problems, she buys health insurance, while her friend Jerry, who has a healthier family, goes without. This is an example of

adverse selection

Which of the following goods best fits the definition of monopolistic competition? wheat; tap water; crude oil; soft drinks

soft drinks

The deadweight loss from monopoly arises because

some potential consumers who forgo buying the good value it more than its marginal cost.

John has been working as a tutor for $300 a semester. When the university raises the price it pays tutors to $400, Emily enters the market and begins tutoring as well. How much does producer surplus rise as a result of this price increase?

between $100 and $200

The experiment called the ultimatum game illustrates that people

care about fairness, even to their own detriment.

Jen values her time at $60 an hour. She spends 2 hours giving Colleen a massage. Colleen was willing to pay as much as $300 for the massage, but they negotiate a price of $200. In this transaction,

consumer surplus is $20 larger than producer surplus.

An efficient allocation of resources maximizes

consumer surplus plus producer surplus.

When a monopolist switches from charging a single price to perfect price discrimination, it reduces

consumer surplus.

If advertising makes consumers more loyal to particular brands, it could ________ the elasticity of demand and ________ the markup of price over marginal cost.

decrease, increase

A firm is a natural monopoly if it exhibits the following as its output increases:

decreasing average total cost.

A technological advance that increases the marginal product of labor shifts the labor ________ curve to the ________.

demand, right

monopolistic competition

describes a market structure in which there are many firms selling products that are similar but not identical. In a monopolistically competitive market, each firm has a monopoly over the product it makes, but many other firms make similar products that compete for the same customers.

Perfect price discrimination

describes a situation in which the monopolist knows exactly each customer's willingness to pay and can charge each customer a different price. In this case, the monopolist charges each customer exactly his or her willingness to pay, and the monopolist gets the entire surplus in every transaction. When a monopolist charges a single price, some consumers get positive consumer surplus, therefore the switch to perfect price discrimination reduces consumer surplus.

If a higher level of production allows workers to specialize in particular tasks, a firm will likely exhibit ________ of scale and ________ average total cost.

economies, falling If a higher level of production allows workers to specialize in particular tasks, then the greater the level of output, the lower the average total cost will be. When long-run average total cost declines as output increases, there are said to be economies of scale, as average total cost falls with rising output.

Fred runs a small manufacturing company. He pays his employees about twice what other firms in the area pay, even though he could pay less and still recruit all the workers he wants. He believes that higher wages make his workers more loyal and hard-working. This is an example of

efficiency wages

The forces of competition in markets with free entry and exit tend to eliminate wage differentials that arise from discrimination by

employers

As the number of firms in an oligopoly grows large, the industry approaches a level of output that is ________ the competitive level and ________ the monopoly level.

equal to, more than

The Prisoners' Dilemma is a two-person game illustrating that

even if cooperation is better than the Nash equilibrium, each person might have an incentive not to cooperate.

The main difference between imposing a tariff and handing out licenses under an import quota is that a tariff increases

government revenue.

The Laffer curve illustrates that, in some circumstances, the government can reduce a tax on a good and increase the

government's tax revenue.

When income inequality is compared across countries, one finds that the United States

has less equality than most advanced nations but more equality than many developing countries.

When a market is in equilibrium, the buyers are those with the ________ willingness to pay, and the sellers are those with the ________ costs.

highest, lowest

Ricky leaves his job as a high school math teacher and returns to school to study the latest developments in computer programming, after which he takes a higher-paying job at a software firm. This is an example of

human capital

If the benefits from an antipoverty program are phased out as an individual's income increases, then the program will

increase the effective marginal tax rate that the poor face.

In a market with a binding price ceiling, an increase in the ceiling will ________ the quantity supplied, ________ the quantity demanded, and reduce the ________.

increase, decrease, shortage

Peanut butter has an upward-sloping supply curve and a downward-sloping demand curve. If a 10 cent per pound tax is increased to 15 cents, the government's tax revenue

increases by less than 50 percent and may even decline.

Eggs have a supply curve that is linear and upward-sloping and a demand curve that is linear and downward-sloping. If a 2 cent per egg tax is increased to 3 cents, the deadweight loss of the tax

increases by more than 50 percent.

When the government levies a tax on a good equal to the external cost associated with the good's production, it ________ the price paid by consumers and makes the market outcome ________ efficient.

increases, more

The two largest sources of tax revenue for the U.S. federal government are

individual income taxes and payroll taxes for social insurance.

A negative income tax is a policy under which

individuals with low income get transfers from the government.

A linear, downward-sloping demand curve is

inelastic at some points and elastic at others.

George has a life insurance policy that pays his family $1 million if he dies. As a result, he does not hesitate to enjoy his favorite hobby of bungee jumping. This is an example of

moral hazard

production possibilities frontier

is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. Because resources are scarce, not every conceivable outcome is feasible. With the resources it has, the economy can produce at any point on or inside the production possibilities frontier, but it cannot produce at points outside the frontier. An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available. Points on (rather than inside) the production possibilities frontier represent efficient levels of production.

budget constraint

is a line that shows the consumption bundles that the consumer can afford. In this case, it shows the trade-off between pizza and soda that Emilio faces. The slope of the budget constraint reflects the relative prices of pizza and soda; therefore, in order for the curve to shift parallel to the original curve, the relative prices must remain the same. If the prices double (that is, the price of pizza rises to $20 and the price of soda rises to $4) and income quadruples (rises from $100 to $400), the price ratio remains the same, but Emilio can afford more of both goods, and so the budget constraint will experience a parallel outward shift.

Adverse selection

is a problem that arises in markets in which the seller knows more about the attributes of the good being sold than the buyer does. In the market for health insurance, the insurer runs the risk of insuring patients who are of poorer health than the average person.

moral hazard

is a problem that arises when a principal cannot perfectly monitor an agent's behavior, so that the agent has an incentive to engage in behavior that the principal considers undesirable. In this case, George (the agent) chooses to take less care to protect his own life than the principal (the life insurance company) would like, given that the life insurance company will suffer some of the consequences if he dies.

If a profit-maximizing, competitive firm is producing a quantity at which marginal cost is between average variable cost and average total cost, it will

keep producing in the short run but exit the market in the long run.

The Condorcet Paradox illustrates Arrow's Impossibility theorem by showing that pairwise majority voting

leads to social preferences that are not transitive.

Charlie buys only milk and cereal. Milk is a normal good, while cereal is an inferior good. When the price of milk rises, Charlie buys...

less milk and more cereal.

If an oligopolistic industry organizes itself as a cooperative cartel, it will produce a quantity of output that is ________ the competitive level and ________ the monopoly level.

less than, equal to

If an oligopoly does not cooperate and each firm chooses its own quantity, the industry will produce a quantity of output that is ________ the competitive level and ________ the monopoly level.

less than, more than

A competitive firm maximizes profit by choosing the quantity at which

marginal cost equals the price.

A monopolistically competitive firm will increase its production if

marginal revenue is greater than marginal cost.

A competitive firm's short-run supply curve is its ________ cost curve above its ________ cost curve.

marginal, average variable Firms maximize profits by producing the quantity at which marginal revenue is equal to marginal cost. A competitive firm's marginal revenue equals the market price, so for any given price, the profit-maximizing quantity of output is found by looking at the intersection of the price with the marginal-cost curve. That is, a competitive firm's marginal-cost curve determines the quantity of the good the firm is willing to supply at any price. However, if the price is less than the average variable cost in the short run, the firm will shut down and produce zero output. Therefore, a competitive firm's short-run supply curve is its marginal-cost curve above its average-variable-cost curve.

price elasticity of demand

measures how much the quantity demanded responds to a change in price. Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price. Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from such a good to others. In contrast, goods without close substitutes, such as a unique life-saving medicine, have a less elastic demand.

price elasticity of supply

measures how much the quantity supplied responds to changes in the price. Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price.

Pretzel stands in New York City are a perfectly competitive industry in long-run equilibrium. One day, the city starts imposing a $100 per month tax on each stand. How does this policy affect the number of pretzels consumed in the short run and the long run?

no change in the short run, down in the long run A monthly tax is an example of a fixed cost, because it does not change with the quantity of output produced. A firm chooses to shut down if the price of the good is less than the average variable cost of production, which does not include fixed costs, so there is no change in the number of pretzels consumed in the short run. In the long run, if the price is less than the average total cost (which includes fixed costs), a firm chooses to exit the market. Because the fixed cost increase will drive some firms' average total costs higher than the price, this will cause firms to exit (and the number of pretzels consumed to go down) in the long run.

Common resources are

overused in the absence of government.

Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer's willingness to pay is

positive but less than the marginal seller's cost.

The anti-trust laws aim to

prevent firms from acting in ways that reduce competition.

New firms will enter a monopolistically competitive market if

price is greater than average total cost.

Which categories of goods are excludable?

private goods and club goods

When a nation opens itself to trade in a good and becomes an importer,

producer surplus decreases, but consumer surplus and total surplus both increase.

Diminishing marginal product

refers to the fact that as the inputs to production increase, the marginal product declines, causing the production function to get flatter as output increases. This also means that each subsequent increase in quantity requires a larger increase in inputs, causing total cost to rise at an increasing rate (that is, get steeper).

Before selling anyone a health insurance policy, the Kramer Insurance Company requires that applicants undergo a medical examination. Those with significant preexisting medical problems are charged more. This is an example of

screening

A business consulting firm hires Vivian because she was a math major in college. Her new job does not require any of the mathematics she learned, but the firm believes that anyone who can graduate with a math degree must be very smart. This is an example of

signaling

If a monopoly's fixed costs increase, its price will _____, and its profit will _____.

stay the same, decrease

When a good is taxed, the burden of the tax falls mainly on consumers if

supply is elastic, and demand is inelastic.

The discovery of a large new reserve of crude oil will shift the ________ curve for gasoline, leading to a ________ equilibrium price.

supply, lower

An increase in ________ will cause a movement along a given demand curve, which is called a change in ________.

supply, quantity demanded

A perfectly competitive firm

takes its price as given by market conditions.

A toll is a tax on those citizens who use toll roads. This policy can be viewed as an application of

the benefits principle.

An increase in the supply of a good will decrease the total revenue producers receive if

the demand curve is inelastic

A utilitarian believes that the redistribution of income from the rich to the poor is worthwhile as long as

the distortionary effect on work incentives is not too large.

If a nation that imports a good imposes a tariff, it will increase

the domestic quantity supplied.

If a nation that does not allow international trade in steel has a domestic price of steel lower than the world price, then

the nation has a comparative advantage in producing steel and would become a steel exporter if it opened up trade.

Diminishing marginal product explains why, as a firm's output increases,...

the production function gets flatter, while the total cost curve gets steeper.

A tax on a good has a deadweight loss if

the reduction in consumer and producer surplus is greater than the tax revenue.

Rawls's thought experiment of the "original position" behind the "veil of ignorance" is meant to draw attention to the fact that

the station of life each of us was born into is largely a matter of luck.

The ability of firms to enter and exit a market over time means that, in the long run,

the supply curve is more elastic.

If firms are competitive and profit maximizing, the demand curve for labor is determined by

the value of the marginal product of labor.

When two individuals produce efficiently and then make a mutually beneficial trade based on comparative advantage,

they both obtain consumption outside their production possibilities frontier. By producing efficiently and then making a mutually beneficial trade based on comparative advantage, both individuals obtain consumption outside their production possibilities frontier. This is because trade allows each individual to specialize in doing what he does best, leading to an overall increase in production and consumption for both parties.

Which goods will a nation typically import?

those goods in which other nations have a comparative advantage Because of the benefits of specialization and trade, countries tend to produce goods in which they have a comparative advantage. Therefore, a nation will typically import those goods in which other nations have a comparative advantage and export those goods in which it has a comparative advantage over other nations.

The Coase theorem does not apply if

transaction costs make negotiating difficult

Public goods are

underprovided in the absence of government.

The price of coffee rose sharply last month, while the quantity sold remained the same. Each of five people suggests an explanation: Tom: Demand increased, but supply was perfectly inelastic. Dick: Demand increased, but it was perfectly inelastic. Harry: Demand increased, but supply decreased at the same time. Larry: Supply decreased, but demand was unit elastic. Mary: Supply decreased, but demand was perfectly inelastic.

who could possibly be right? Tom, Harry, and Mary

If the corporate income tax induces businesses to reduce their capital investment, then

workers bear some of the burden of the tax.

Measuring how much discrimination affects labor market outcomes is difficult because

workers differ in their attributes and the types of jobs they have.

Factors That Determine Supply

• Price of inputs • Production technology • Number of producers • Expectations of producers