Final Exam Review PDF

Final Exam Review The exam is not limited to the details covered in this review. Positive vs Normative Statements Positive statements: Descriptive; attempt to describe the worlds as it is. Example: “Minimum wage laws cause unemployment.” Normative statements: Prescriptive; attempt t...

Final Exam Review The exam is not limited to the details covered in this review. Positive vs Normative Statements Positive statements: Descriptive; attempt to describe the worlds as it is. Example: “Minimum wage laws cause unemployment.” Normative statements: Prescriptive; attempt to prescribe how the world should be. Example: “The government should raise the minimum wage.” Comparative Advantage Comparative Advantage – the ability to produce a good at a lower opportunity cost than another producer àSpecialize according to comparative advantage Opportunity Cost – what must be given up to obtain something Supply and Demand Law of Demand When the price of a good rises, the quantity demand of the goods falls Law of Supply When the price of a good rises, the quantity supplied of the good rises Note: a change in the price results in a movement along the curve. Supply and Demand Consider the market for peanut butter. What would happen to the equilibrium price and quantity given the following events? A. Price of almond butter rises. B. Price of peanuts increases. C. Buyers experience an increase in their income. D. Events A and B happen simultaneously. E. Events B and C happen simultaneously. Elasticity Price Elasticity of Demand How much the quantity demanded of good X responds to a change in the price of good X Price Elasticity of Supply How much the quantity supplied of good X responds to a change in the price of good X Income Elasticity of Demand How much the quantity demanded of good X responds to a change in consumer’s income Cross-price Elasticity of Demand How much the quantity demanded of good X responds to a change in the price of good Y Questions 1. Which good would have a higher elasticity of demand? a) Required Textbooks or Mystery Novels b) Rootbeer or Water 2. Which good is a normal good? a) McDonalds coffee vs Starbucks coffee b) instant ramen noodles vs ramen at a restaurant 3. Are they substitutes or complements? a) hotdogs and ketchup b) iPhone and Google Pixel 7 Market Efficiency Total surplus = CS + PS Consumer surplus = Value to buyers – Amount paid by buyers Buyers’ gains from participating in the market Value to buyers = willingness to pay Producer surplus = Amount received by sellers – Cost to sellers Sellers’ gains from participating in the market Cost to sellers = willingness to sell Total surplus = Value to buyers – Cost to sellers Note: An Efficient Market maximizes total surplus. Government Policies Price Controls Price Ceiling – legal maximum on the price Price Floor – legal minimum on the price Taxes government can make buyers/sellers pay a specific amount on each unit bought/sold Tax incidence – the share of tax burden The share of tax burden is the same regardless of who the tax is imposed upon. Less elastic demand curve compared to supply curve means that Buyers have a greater share of tax burden. Taxes result in a deadweight loss Elasticity, Taxes and Deadweight Loss Would the DWL of a tax be larger if the tax were on: 1. Breakfast cereal or sunscreen? 2. Hotel rooms in the short run or hotel rooms in the long run? 3. Groceries or meals at fancy restaurants? What happens to the deadweight loss is the tax is doubled? Costs of Production What is the difference between accounting profit and economic profit? Explicit cost – exchange of cash Implicit cost – no exchange of cash; opportunity cost Diminishing Marginal Product – as you add more inputs, the average input has less fixed resources to work with and will be less productive Marginal Cost – increases as you produce more output Average Fixed Cost – decreases are you produce more output Average Total Cost – ATC curve is U-shaped Efficient Scale – the quantity the minimizes ATC Perfectly Competitive Market 1. Market with many buyers and sellers 2. Buys/sells identical products 3. No barriers to entry/exit à firms can freely enter/exit the market Marginal Revenue = Price à because firms are price takers à only true for firms in competitive markets Since Profit Max condition is to sell Q where MR = MC and P = MR, then perfect competitive equilibrium price equals marginal cost (i.e. P = MC). à Competitive Equilibrium is efficient (no deadweight loss). Monopoly 1. Firm is the sole seller of a product (no supply curve) 2. Firm has market power (can influence market prices) 3. There are barriers to entry (other firms cannot enter the market) Marginal Revenue < P à to sell more, firm needs to lower its price Profit Maximization: à sell Q at MR = MC à set highest possible Price based on Market Demand Since P > MC, then monopoly market is inefficient. There is deadweight loss. Monopolistic Competitive Market 1. Market with many buyers and sellers. 2. Product differentiation: firms sell similar but differentiated products The firms have market power and face a downward sloping demand curve 3. Free entry/exit à zero economic profit in the long run Profit Maximization: à sell Q at MR = MC à set highest possible Price based on Demand Monopolistically Competitive market is inefficient (there is DWL) because: Markup of price over marginal cost (i.e. P > MC) Firm entry/exit à Product-variety externality vs. Business-stealing externality Advertising Markets with highly differentiated goods have more incentive to advertise Acts as a signal of quality: spending more on advertising implies better quality product Defenders of Advertising: Provides useful information to buyers Advertising promotes competition because it reduces market power. Critiques of Advertising: Manipulates people’s tastes Advertising impedes competition because it fosters brand loyalty (higher markups) Exercises: 1. Suppose when a monopolist produces 50 units, its average revenue is $8 per units, its marginal revenue is $4 per unit, its marginal cost is $4 per unit, and its total average total cost is $3 per unit. Is the monopolist profit maximizing? Explain your answer. 2. Betty’s Flower Shop has average variable costs of $3 and average fixed costs of $7 when it produces 100 units of output. What is the firm’s total cost? 3. Firms in a monopolistically competitive market are earning positive economic profit. What will happen to the market in the long-run?