Econ 101 Exam 1

Price Elasticity of Supply

-PES measures producers' responsiveness to price changes -Producers are sometimes price sensitive - a small price can change lead to a large change in supply (ELASTIC) -Other times producers do not change the quantity supplied or only make slight changes to the quantity they supply (INELASTIC - insensitive to price change) -Price elasticity influences the slope of the supply curve

Four fundamental questions for command system

1. Central planning board decides who gets the goods/services 2. Central planning board decides who how they are produced 3. Central planning board decides who gets the goods and services 4. Command is a follower society and technological advances/capital accumulation is not promoted (self-interest is not a thing)

When the equilibrium changes, ask yourself these three questions:

1. Does this event first impact demanders or producers/sellers? 2. Does the event increase or decrease demand (supply)? 3. Draw the graph so you can determine: what will happen to the equilibrium price? Quantity?

Equilibrium change example 2: Price of oranges increases

1. Does this event first impact demanders or producers/sellers? Both. Law of demand states that as price increases, the quantity demanded decreases. There wasn't a shifting of curves, just movement along the already-existing curve. 2. Does the event increase or decrease demand (supply)? Demand decreases 3. Draw the graph so you can determine: what will happen to the equilibrium price? Quantity?

Equilibrium change example 1: new medical evidence reports that consumption of apples reduces the incidence of cancer

1. Does this event first impact demanders or producers/sellers? Demanders, because they will rush to buy more apples 2. Does the event increase or decrease demand (supply)? Increases demand 3. Draw the graph so you can determine: what will happen to the equilibrium price? Quantity? There will be a shortage of apples; therefore, the graph shifts to the right and equilibrium price will go up to slow the demand of apples to create a new, higher equilibrium

Example 3: equilibrium change - The minimum wage increases. How will this impact the market for fast food?

1. Does this event first impact demanders or producers/sellers? Producers because they have to pay employees more 2. Does this event increases or decrease demand (supply)? Decrease supply 3. Draw graph: what will happen to equilibrium price? Quantity? Supply curve shifts to the left; employers can't afford to buy as much food to sell, so to prevent a shortage they raise food price

Gov't Role in Economy

"Active, but limited"

Specialization quote

"Self-sufficiency breeds inefficiency"

Command System: what is it also known as, who owns the factors of production, how are decisions made, and what are countries with this type of system?

Also known as socialism or communism. Gov't ownership of economic resources (therefore people don't have full control of what their job or entrepreneurial ability is). Decisions are made by the Central Planning Board on what goods/services are produced and the prices. North Korea and Cuba are examples.

Supply

Amount producers are WILLING and ABLE to produce at a given price

Determinants of supply

Aside from prices: Resource prices Technology Taxes/subsidies Prices of other goods Price expectations Number of sellers in the market

Elastic or inelastic? Bottled water, toothpaste, Crest toothpaste, ketchup, diamond bracelets, Windows OS

Bottled water: elastic Toothpaste: inelastic Crest toothpaste: elastic Ketchup: elastic Diamond bracelets: elastic Windows OS: inelastic

Rival and non-excludable goods

Common goods (fisheries, mines, forests, collecting sea shells)

Excludability vs. Non-Excludability

Excludable: Sellers can you prevent people from consuming product if they didn't pay for it Non-excludable: can't prevent people from consuming the product; like a bike path, park, etc.

Examples of price discrimination

Flights (charge business travelers more bc they buy at the last minute - inelastic) Utilities (charge more during peak hours) Movies/golf (higher evening/weekend rates) Coupons (discounts for those willing to seek them out - lower willingness to pay) Post office (same price to send letter across the street as across the country - reverse price discrimination)

Specialization

Happens in market system; it pertains to the division of labor and geographic separation that allows individuals to specialize in what they're good at and enjoy or what makes them the most money. They use the resources of themselves, the region, or nation to produce one or a few goods and services rather than the entire range. Makes use of differences in ability, fosters learning by doing, saves time, and allows different areas to produce different things

Law of Demand

Other things equal, as price falls, the quantity demanded rises, and as the price rises the quantity demanded falls.

Perfectly Inelastic vs Elastic

PI: Demand doesn't change, consumers unaffected by price changes (straight vertical line on graph) PE: All that matters is the price of the product: if price stays the same, I will consume an unlimited amount of the product; if price goes above that, I wouldn't demand the product at all (think about farmers market)

Perfectly Inelastic Supply, in-bewteen supply (short run), Elastic supply (long run)

Perfect: Same quantity for sell no matter the price - a fixed amount and sellers can't change the number of cars (or tomatoes) they produce In-between: Steep but not vertical supply curve; getting cars from other lots but still don't have many Elastic: Line becomes flatter; sellers have ability to change quantity of cars they produce

Resource Market and Product Market in the Circular Flow Diagram

Resource market: Costs flow from businesses into the market and turn into wages, rent, interest, and profits (which are determined there along with capital and entrepreneurial ability) Product market: consumption expenditures from Households flows there and turns into revenues for businesses. Prices and demand for products are determined.

Investment

Spending that pays for the production and accumulation of capital goods

Producer Surplus

The difference between price the producer receives and their willingness to produce (extra happiness from a high price)

Determinants of Price Elasticity

The more substitutes an item has, the more elastic the demand and the more price sensitive we are. The more specific the market, the greater the elasticity (if only a black Subaru Forrester goes up in price it will have a more elastic demand than all Subaru cars because it's more specific). The higher the percentage of our income, the more elastic the demand. When an expensive good increases (or decreases) in price it may take us longer (or less time) to save money for the product, changing quanitity that we demand Luxury items have more elastic demand relative to goods that are considered a necessity

Conditions for success for price discrimination

♣ Must have some control over price- must have some monopoly power or be a monopolist to have control over price ♣ Market segregation (determine which groups/people have the willingness to pay a higher price) - usually based on different price elasticities of demand ♣ Not resalable

Calculating consumer surplus with graph

♣ Pd is highest consumer in market is willing to pay ♣ P1 is the equilibrium price ♣ Q1 is the equilibrium quantity ♣ Formula: (1/2) * (Pd - P1) * Q1

Small market shares vs Independent action

♣ Small market shares: each firm has a comparatively small percentage of the total market and consequently has limited control over market price ♣ Independent action: there is no feeling of interdependence because of the number of firms; each can determine its own pricing policy without considering possible reactions of rival firms

Example 4: equilibrium change - A publishing company can charge a higher price for romance novels. How does this affect the market for mystery novels?

1. Does this event first impact demanders or producers/sellers? Sellers bc they'll want to make more money by selling more romance novels 2. Does this event increases or decrease demand (supply)? Decreases supply of mystery novels; sellers don't want as many 3. Draw graph: what will happen to equilibrium price? Quantity? Supply shifts to the left; price of mystery novels increase to make up for lack of selling them (so they make more selling fewer)

Price discrimination or not? 1. Offering a child's price at all you can eat buffet 2. Offering child's price for movie ticket

1. Offering a child's price for an all you can eat buffet? Not price discrimination b/c it costs a child and an adult different prices to get the buffet (child eats less) 2. For a movie theatre ticket? Yes, it's price discrimination because it costs the movie theater the same to have the child and adult in the theater but the child gets to pay a lower price

Four fundamental questions: market system

1. We decide/vote -with money - on what will be produced 2. We use the method of production that minimizes costs to produce goods and services 3. Who will get the goods and services is determined by willingness to pay and ability to pay 4. Market uses technological advances and capital accumulation to promote progress. We have self-interest that motivates us to strive for more - a bigger income in the future.

Scarcity

A fundamental economic problem of having seemingly unlimited human wants and needs in a world of limited resources. Also, humans don't have unlimited income. Society has insufficient productive resources to fulfill all human wants and needs.

Price Ceiling: what is it? when is it binding? What is the result?

A legal maximum on the price of a good or service (think rent in cities - gov't sets maximum to help poor) When the price ceiling prevents the market from moving to equilibrium it is known as binding Result of a binding price ceiling is a SHORTAGE

Change in quantity demanded

A movement from one point to another point/from one price-quantity combination to another on a fixed curve. The cause is an increase or decrease in the price of the product under consideration (Ex. decline in cost of coffee will increase quantity that is demanded; the demand didn't change, so the curve stays in place)

Price Ceilings and the Equilibrium

A price ceiling above the equilibrium price IS binding - makes the equilibrium illegal A price ceiling below the equilibrium price has no effect on the market outcome This results in a binding constraint - the equilibrium price is too high and illegal When quantity demanded is greater than quantity supplied, there is a shortage

Price Floors and the Equilibrium

A price floor below the equilibrium price is NOT binding - has no effect on the market outcome, so the equilibrium price will be the price received/paid. A price floor ABOVE the equilibrium price makes the equilibrium illegal Results in a binding constraint - the equilibrium price (what workers were being paid before gov't intervened) is too low and illegal

What is a price floor? And when is it binding? What is the result?

A price floor is a legal minimum on the price of a good. When the price floor prevents the market from moving to equilibrium it is known as binding. Result of a binding price floor is a surplus; if it is not binding, there is no surplus and you have an equilibrium

Change in Demand

A shift of the demand curve to the right or to the left; it occurs because the consumer's state of mind about purchasing the product has been altered in response to a change in one or more determinants of demand

Budget Line

Aka a "constraint;" it's a schedule or curve that shows various combos of two products a consumer can purchase with a specific money income. Everything on or below the line is a possibility (attainable) but everything above is not

Market system: what is it also known as, who owns the factors of production, how are decisions made, and what are countries with this type of system?

Also known as capitalism. There is private ownership of resources (by individual households - we are sovereign/in control). Decisions are made on/in markets (supply and demand determine who gets the good and what is paid for it). US, Canada, and UK are examples.

Elasticity and Tax Incidence: Demand is more elastic than supply (inelastic)

Buyers pay much smaller portion because they have inelastic demand and they leave the market Inelastic demand and elastic supply: buyers bear more of the burden Elastic demand and inelastic supply: sellers bear more of the burden

Elasticity and Tax Incidence: Supply is more elastic than demand

Buyers' share of tax burden is amount above equilibrium More elastic the supply, the less sellers pay Buyers have more inelastic demand, so they pay more of the tax

Change in Supply

Change in supply means a change in the schedule and a shift of the curve o An increase in supply shifts the curve to the right o A decrease in supply shifts it to the left (the cause of such a movement is a change in the price of the specific product being considered)

Oligopoly and pricing behavior

Characteristics of certain games of strategy. The way firms play must depend on how their opponent(s) play. Firms essentially work together to charge the monopoly price (but they can't "collude" because that is a cartel and thus illegal in the U.S.)

Price discrimination:

Charging different prices (depends on different peoples' or groups' willingness to pay) when the differences are not justified by the cost difference. The goods purchased cost the firm the same amount to produce.

Non-rival and excludable goods

Club goods/artifically scarce goods (cable TV, private parks, cinemas, ski slopes)

Calculate Total Surplus

Consumer surplus plus the producer surplus ~ TS = (1/2) * (Pd - Ps) * Q1 ~ Don't need to know equilibrium price if using this formula

Determinants of Demand (5)

Consumers' tastes and preferences The number of consumers in the market Consumers' incomes The prices of related goods Expected prices

Barriers to Entry

Economies of Scale (smaller scale new firms have a difficult time entering because of high fixed costs - the avg. cost declines with a larger firm) Legal barriers (patents and licenses) Ownership of essential resources Pricing schemes (ex. Walmart moves into town, drops prices super low so people will shop, then raises prices) Oligopolies exist most commonly because of economies of scale

Roles of economists (2) and Positive vs Normative statements

Economists have 2 roles: to inform about the economy (tell the facts) and give advice on improving the economy (opinion) Positive: telling the facts/info Normative: giving advice or opinions

Product Variety in Monopolistically Competitive

Firms in this market type must constantly manage: Price, Product, and Advertising This allows customers to benefit from a greater array of choices and products

Two goods produced by the economy

Food products and manufacturing equipment Food products symbolize consumer goods - products that satisfy our wants directly Manufacturing equipment symbolizes capital goods, or products that satisfy our wants indirectly by making possible more efficient production consumer goods

Who are profits earned by in the circular flow diagrams?

Households, NOT businesses. They're earned by households with entrepreneurial ability. Businesses get revenue, which is then used to buy resources/factors of production.

Households and Businesses in the Circular Flow Diagram

Households: sell resources/factors of production to Resource Market and buy products (aka goods and services) from the Product Market via businesses Businesses: Buy resources from the Resource market that households provided and sell products to the product market

Determinants of PES

How easy is it for the producers to change the amount they produce? Some items are not reproducible - these have very inelastic supply Time is the most important determinant

Economics and what it assumes

How to make the best use of our scarce resources. Since resources are scarce, we make decisions. "The social science concerned with how individuals, institutions, and society make choices under conditions of scarcity." Economics assumes that people are rational and self-interested and want to max their utility

More on Market System: property rights, freedoms, self-interest, competition, technology

Individuals have right to own/control/dispose of/bequeath land. Also extends to intellectual property through investment, exchange, innovation, copyrights, and trademarks. Individuals have freedom of enterprise and choice: firms can produce and sell anything they want (except drugs, prostitutes, etc.) Each economic unit tries to advance their own goal (self-interest) Competition: buyers and sellers have the choice to enter and leave the market Tech: monetary rewards for new products or production techniques accrue directly to the innovator; encouraged

Correlation between supply and demand

Inverse correlation between price and quantity when talking about demand Direct correlation between price and quantity when talking about supply

Pure market/capitalism is also called

Laiseez-faire ("let it be")

Macro vs Micro

Microeconomics: individuals' (person/firm/industry) decision-making process Macroeconomics: the big picture, looking at the whole economy

Money and the poor in market system

Money is a social invention to facilitate exchanges of goods and services. A big complaint about capitalist societies is that they leave out the poor.

Negative v Positive Externality Review

Negative: shift to left of original starting point - when input costs are low, there's an increase in supply, overproduction of product, to reduce quantity produced we add a tax (which decreases price sellers receive and increases price buyers pay). Positive: shift to right of original starting point - when others are willing to pay for a product there's an increase in demand, underconsumption of the product, to increase quantity purchased we add a subsidy (which increases price sellers receive and decreases price buyers pay)

For which type of good do biggest market failures most commonly exist and why?

Non-rival and non-excludable goods because of the "free riders" problem (customers have incentive to underestimate the value of a good in order to secure its benefits at a lower/no cost) Gov'ts often move into the market to move it toward equilibrium and/or may provide the public good or tax/subsidize it

Law of Supply

Other things equal, as price falls, the quantity supplied falls, and as the price rises, the quantity supplied rises

Rival and Excludable Goods

Private goods/typical goods (clothes, food, flowers, buying milk, etc.)

Product Differentiation types

Product attributes: physical or quality differences- features, materials, design, and workmanship Customer service (buying at BestBuy with Geek Squad vs Walmart) Accessibility and Location (Walgreens charges higher prices, but there's one on every corner- makes it fast and quick for customers) Brand Name and Packaging •Celebrity association •Wording on package •Fancy packaging

Calculate Producer Surplus

Ps is lowest price that seller is willing to accept P1: equilibrium price Q1: equilibrium quantity Formula: (1/2) * (P1 - Ps) * Q1

Non-rival and non-excludable goods

Public goods/collective goods (air, news, sun, watching fireworks)

Four Types of Markets

Pure Competition Pure Monopoly Monopolistically Competitive Oligopoly

Elastic vs Inelastic Demand

Responsiveness of the quantity of a product demanded by consumers when the product price changes is measured by product's price elasticity of demand Elastic: customers highly sensitive to price changes (if price goes up some it's okay, they'll likely still buy it) Inelastic: Consumers pay much less attention to price change (mostly for necessities - like health care)

What are externalities? External benefits? External costs? What happens when external benefits occur in the market?

Side effects borne by people who are not directly involved in market exchanges Benefit: positive side effects of ordinary economic activities Cost: negative side effects of ordinary economic activities When the benefits occur, the private market provides to little of the product

To determine a subsidy...

Start at equilibrium Move to the right Stop when the price difference between the supply curve and the demand curve is equal to the subsidy **Supply curve should be above the demand curve

To determine tax...

Start at the equilibrium Move to the left Stop when price difference between the demand curve and the supply curve is equal to the tax

Society's economic problem

The 4 types of Scarce resources (aka factors of production): land, labor, capital (a good we use to make more goods: such as a tractor or factory equipment), and entrepreneurial ability (takes risk and time, not everyone has that ability/dedication). All these things are "fixed" (scarce)

Consumer surplus

The difference between the max price a consumer is willing to pay for a product and the price they actually do; extra happiness from getting a low price

Producer surplus

The difference between the price received and the producer's willingness to produce

How do economic systems differ?

The differences lie in who owns the factors of production, and what method is used to motivate, coordinate, and direct economic activity

Individual's economic problem

We can't have unlimited resources because we can only work so many hours in a day. Also, we have income restraints (certain amount an hour/year). We have to determine which of our unlimited wants should be purchased with our limited resources

Negative Externality graph

We're operating at C (bottom right of triangle) when we should be operating at A (left of triangle). We're operating at C due to overallocation. Point B (top right) is what we'd operate at if we realized *full* cost to society. St line (top line) represents full cost to society (line that A and B are on). S line means actual supply.

Positive Externality Graph

We're operating at X (bottom left) when we should be operating at z (up and right). Y (top) is where we'd be if we realized *full* cost to society. We are under allocating land, labor, capital, and entrepreneurial ability. "If I gave my neighbor $200 to fix up his house, he would want (demand) more."

Negative Externality explanation

We're spending/using too much land, labor, capital, and entrepreneurial ability on production of this good. "If I had to properly dispose of my waste, it would cost my firm more and so it would increase my cost to supply and decrease my quantity supplied, so I'll dump it and the community can just deal with it."

Four Fundamental questions:

What goods and services will be produced? How will the goods and services be produced? Who will get the goods and services? How will the system promote progress?

What are Market Failures, how do you improve market failures, and what are the two types?

When a market fails to produce the equilibrium quantity and/or no private seller is willing to supply the product, it leads to overallocation or under allocation. Gov't intervention can improve the outcome (think US defense and healthcare industry) Two types of market failures: public goods and externalities

Natural Monopoly

When an economy of scale gives rise to a monopoly. The gov't will only step in if the natural monopoly sets outrages prices for its goods/services, etc.

Equilibrium

Where price and quantity are determined - buyers and sellers come together. Occurs where the quantity demanded and quantity supplied are equal.

Aggregate

a collection of specific economic units treated as if they were one unit

Marginal analysis

cost versus benefit (you stop eating tacos when the marginal benefit of the next taco is less than the marginal cost: your expected utility from the taco is less than the money it costs to purchase, so cost outweighs benefit)

Creative destruction

creation of new products and production methods completely destroys the market positions of firms that are wedded to existing products and older ways of doing business

Other things equal assumption

economists assume that all variables except those under immediate consideration are held constant for a particular analysis

All goods can be divided into ___ categories based on ___ characteristics (and what are they)

four categories; two characteristics Rival vs. Non-rival Excludable vs. Non-excludable

Production Possibilities Table

lists the different combinations of two products that can be produced with a specific set of resources, assuming full employment

An increase in supply happens when...

o Cost of an input falls o Business develops more efficient tech o Number of sellers increases o Price of a substitute in production falls o The price of a compliment in production increases o The price of the product is anticipated to fall in the future

Gov'ts must determine these four questions before intervening in a market collapse

o Is this a market failure? / Does a market failure exist? o What is the cause? o Who received the extra benefit (if a positive externality)? o Who paid the extra cost (if a negative externality)?

A decrease in supply happens when...

o The number of sellers decreases o The price of a substitute in production rises o The price of a compliment in production falls o The price of the product is anticipated to rise in the future

Constant opportunity cost

opportunity cost of something remains the same as more of another thing is purchased

Opportunity cost

to obtain more of one thing, society forgoes the opportunity of getting the next best thing- a sacrifice

Gov't Intervention in Markets

• Attempt to correct negative externalities, control pollution, and correct positive externalities (via subsidies, tax refunds, or deductions)

Demand Side Market Failure

• Private demand curves understate consumers' full willingness to pay for a good service o Under-allocation of resources o Example: public art: a lot of people like it, but not everyone voices their opinion and says they'd pay for the art, meaning there's not as much art as there could be o Examples: public parks, fireworks • Many can enjoy the benefits without paying

Supply Side Market Failure

• Private supply curves understate the full cost of producing a good or service o Overallocation of resources o Example: factory emitting pollution, farm abusing the land or water o The firm is not paying the full cost of producing the product

Factors that shift demand curve to the left (7)

• The good falls out of style • A decrease in the number of buyers • Income falls (normal good) • Income increases (inferior goods) • Price of a substitute good falls • Price of a complementary good rises • There is a belief that the future price (or our income) will decline

Factors that shift demand curve to the right (7)

• The good is in style • An increase in the number of buyers • Income rises (normal good) • Income decreases (inferior good) • Price of a substitute good increases • Price of a complementary good falls • There is a belief that the future price of a good will increase

Rivalry vs. Non-Rivalry

•Rival: When one person buys and consumers a product, it is not available for other people to buy and consume (buying ice cream - if someone else wants it, they'll have to fight me for it) •Non-rival: More than one person can have it at the same time (paying for cable TV or internet - more than one person use it at once)