AP Econ Unit 2 Review

The Law of Diminishing Marginal Utility

As we add more units of a good or service, each additional unit added provides a decreasing amount of utility (or satisfaction). Think of drinking; as an adult over the age of 21 drinks, the first drink is very nice, the next drink is nice, the drink after that is satisfying, the drink after that, meh, and if he continues to drink, eventually there will be no utility and additional drinks will only make him feel worse.

How can government create a shortage in a competitive market?

By instituting a price ceiling below the equilibrium price. Example: Rent control.

How can government produce a surplus in a competitive market?

By instituting a price floor above the equilibrium price. Example: minimum wage

Show how there can be an increase in the equilibrium quantity and a decrease in the equilibrium price in strawberries in the North in summer and briefly explain what happened.

An increase in the supply of strawberries (determinant: input costs) would result in a lower price for strawberries but an increased quantity.

Consumer Surplus and Producer Surplus

Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually do pay (i.e. the market price). Producer Surplus is the difference between the amount a producer of a good receives and the minimum amount the producer is willing to accept for the good. The difference, or surplus amount, is the benefit the producer receives for selling the good in the market.

"Gold is valuable because so many people hunt for it."

False. Gold is valuable because of supply and demand. There's not a lot of it and people like it.

State Representative Smith feels that New York can raise revenue by increasing license plate and registration fees 500%. With five times the revenue, the state can solve a lot of problems. Is he right? Why or why not?

He's wrong. He's assuming that demand for these fees is perfectly inelastic because he says that the increase in revenue would mirror exactly the increase in taxes, but some people, especially in NYC, would not pay those fees because there are substitutes, such as public transportation.

The legalization of narcotics

Legalize narcotics and your supply is going to go up. This will increase Q and decrease P. More people will buy drugs because price fell, moving us along the demand curve.

"An increase in demand increases price. The higher price increases supply. The higher supply decreases price, and price settles down to the original level."

Nopity nope nope. While an increase in demand does increase price, the higher price DOES NOT increase supply, it increases quantity supplied.

Normal Goods and Inferior Goods

Normal goods are those items that one will buy more of as her income increases. Inferior goods are those items that one will buy fewer of as her income increases.

Enforcement of drug laws aimed at users.

Punish the buyers and demand decreases, lowering the price, which would also eliminate some dealers who couldn't make their businesses work with their new, lower revenues.

Enforcement of drug laws is aimed at pushers

Punish the dealers and what happens to supply? Ahhhh... it shifts to the left, which raises the price, which incentivizes other dealers to jump in and take the spots that their friends, now in prison, used to have.

Income Elasticity -5

a negative number indicates that the good being measured is inferior because as income increases, quantity demanded decreases and vice versa, e.g. when you graduate from college and land a real job, you will eat a lot less top ramen.

The Law of Demand

The higher the price, the less quantity will be demanded.

The Law of Supply

The higher the price, the more quantity will be supplied.

The elimination of price Supports would, in our opinion, result in an increase in milk prices within 2 months. Certainly, the immediate effect would be to reduce prices. But as prices fall, demand would increase. We believe this increase in demand would be so strong that within 2 months prices would be higher.

The lobbyist either never learned econ or is counting on your ignorance to support her idiotic statement. If you remove the price floor, the ONLY thing that changes is price, and it slides down to equilibrium. And, as you know, when the only thing that changes is price, then only quantity demanded will change, not demand itself,

Recently the price of beef rose. Show that the rise in price could be consistent with the following scenarios. Briefly explain your thinking. The quantity of beef consumed falling.

The only way price rises and quantity drops is when supply drops.

Recently the price of beef rose. Show that the rise in price could be consistent with the following scenarios. Briefly explain your thinking. The quantity of beef consumed rising

The only way price rises and quantity increases is when demand increases.

Recently the price of beef rose. Show that the rise in price could be consistent with the following scenarios. Briefly explain your thinking. The quantity of beef consumed staying the same.

The only way price rises and quantity stays the same is if there's an increase in demand (which would account for the increase in price and an increase in quantity) AND a decrease in supply, which would also increase price, but would move quantity BACK; technically though, we would have an indeterminate quantity because we don't know exactly how much supply and demand are shifting.

Cross-Price Elasticity -5

a negative number indicates that the goods being measured are complementary because as the price of one increases, that means the quantity demanded of the other decreases, e.g. if the price of hot dogs goes up, you'll buy fewer hot dogs, therefore you will also buy fewer hot dog buns.

Income Elasticity 5

a positive number indicates that the good being measured is normal because as income increases more of it is purchased or conversely, that as income decreases, less of the good is bought, e.g. I just killed my competition and became the greatest narcotraficante the world has ever seen so I will buy more Bentleys.

I sit in the back row of the Barbers' Union where they are discussing a proposal to raise the price of haircuts from $18 to $20. They ask me, an economist, for input. I say, "Many studies have shown that the demand for haircuts is elastic." What should the Barbers' Union do?

They shouldn't raise prices. If demand for their service is elastic and they raise prices, people will buy significantly fewer haircuts (have significantly fewer hairs cut?).

A consumer group believes the prices of necessities such as food, housing, energy, and medical care should be controlled by the government. "People can afford higher prices for luxuries," they reason, "but all of us, and especially the poor, suffer when the prices of necessities rise."

This plan sucks. Price ceilings result in shortages. We're talking about basic needs guys; you DO NOT want a shortage in basic needs because it hurts everyone.

The U.S. government purchased the entire cocaine supply in Colombia.

USA! USA! USA! Okay, j/k. But seriously, if the gov tried to stop drug trafficking by buying all the things, all it would do is push demand to the left, raising the price, therefore incentivizing even more narcotraficantes to get into the act. (Looking at you, CIA).

Make the optimistic assumption that one day you will be a college graduate. Would you support a law to raise the legal minimum wage of college graduates to $50,000

You shouldn't. Price floors create surpluses. There would be less quantity demanded , i.e. fewer jobs for college graduates. So, unless you just want to party for four years and then live at home forever, this would be a really bad call.

Cross-Price 5

a positive number indicates that the goods being measured are substitutes because as the price of one increases, that means the quantity demanded of the other increases, e.g. if the price of hot dogs goes up, you'll buy fewer hot dogs, and will buy more hamburgers as a replacement.

Income Elasticity 0

indicates that the goods are "sticky", i.e. that a change in income has no effect on the quantity demanded for the good.

Cross-Price Elasticity 0

indicates that the goods are independent of each other; a change in the price of one has no effect on the other.